A time to get a little Moody?

6 May 2015

Moody’s downgrade of Trinidad and Tobago

On the 30th April 2015 Moody’s Investor Service downgraded Trinidad and Tobago’s government bond rating from Baa1 to Baa2 and changed the overall country outlook from stable to negative.
Moody’s cited three factors for the downgrade:

  1. The existence of persistent fiscal deficits and the challenging prospects for any meaningful fiscal reforms
  2. The effect of a decline in oil prices on an economy that has limited economic diversification and an over-reliance on oil and gas, leading to an assumption that economic growth prospects will be impaired
  3. The existence of a weak macroeconomic policy framework given a lack of medium-term fiscal strategy, and the inadequate provision of vital macroeconomic data

Moody’s concluded that at Baa2, an investment grade rating for Trinidad and Tobago is still justified given a strong government balance sheet, underpinned by the country’s Heritage and Stabilisation Fund (HSF), a moderate and affordable debt burden, and a strong external position.

First question first – what is a credit rating?

Credit ratings are opinions issued by credit rating agencies. Credit rating agencies are private companies that exist for the purpose of selling their financial analysis to investors (or potential investors).
Credit rating agencies mark potential investments using a scorecard system and each of the three main agencies (Moody’s, Standard & Poor’s and Fitch) have their own unique scoring system. The main scoring system used by Moody’s runs from Aaa to C.
In the case of countries, when an agency writes a report they are assessing the creditworthiness of that country. That is essentially that country’s ability to pay back its debts. The less likely a country is to be able to pay back its debts the lower the rating.

The Moody rationale – factor one:

               The existence of persistent fiscal deficits and the challenging prospects for any meaningful                  fiscal reforms

Since 2009 Trinidad and Tobago’s fiscal accounts have reported recurring deficits in the region of 2-3% of gross domestic product (GDP). This follows on from the previous eight years during which the government of the day operated consecutive fiscal surpluses.
Moody’s is of the opinion that going forward putting the government accounts on a more sound footing will be very challenging if oil prices continue to remain low, and low gas prices in US markets spill-over to other markets. In other words over the next few years expect continued fiscal deficits if market conditions continue to prevail as is.

Beyond this Moody’s is concerned with the lack of a medium term fiscal framework, and an over reliance on one-off measures to cut spending, the effect of which is to ultimately undermine the ability of the authorities to achieve a durable turnaround in fiscal metrics. Under this heading the government comes under some criticism for not using the HSF – originally designed at least in part and in name as a tool to shield the economy against short-term shocks – for the purpose for which it was intended. Add on top the rigid structure of public expenditure, where wages, subsidies, and transfers account for more than 65% of total expenditures, and in Moody’s opinion there is little room in the short term for some fiscal flexibility.
In other words don’t expect an easy or early recovery.

The Moody rationale – factor two

  The effect of a decline in oil prices on an economy that has limited economic diversification                and an over-reliance on oil an gas leading to an assumption that economic growth prospects                will be impaired

Moody’s view on the prospects for the Trinidad and Tobago economy fairly pessimistic with an assumption that GDP growth will rebound to less than 2% in the medium term.
Since Trinidad and Tobago remains heavily reliant on the oil and gas sector and accordingly economic activity and fiscal stability is predicated on the performance of that sector, low prices logically impair the prospects for future growth. Moody’s position is that economic growth has slowed in Trinidad and Tobago as a result of maintenance-related disruption in gas production through 2014 and early 2015, and even though normal production is likely to resume during 2015, the prospects of injecting new investments to boost growth will always be a challenging proposition in the face of declining oil prices.
For the record, Moody’s expect oil prices to remain in the region of $60 during 2015/16.
The Moody rationale – factor three

              The existence of a weak macroeconomic policy framework given a lack of medium-term fiscal              strategy, and the inadequate provision of vital macroeconomic data

Moody’s ranks Trinidad and Tobago’s institutional strength as moderate based upon the World Bank’s governance indicators. Moreover it considers Trinidad and Tobago’s macroeconomic institutional capacity as being weaker than many of its investment grade peers.
Under this heading Moody’s concluded that the absence of a medium term fiscal framework, coupled with a lack of debt management strategy, represent important policy shortcomings – perhaps shortcomings that should not exist in a country with an investment grade.
Coupled to this Moody’s noted that Trinidad and Tobago compares poorly in terms of the quality (and almost certainly the timeliness) of statistical information placed in the public domain.
If Trinidad and Tobago were a school student the report card under this heading would surely say “should have done a lot better.”

Does it really matter? – Don’t get too Moody

Credit rating agencies can often be criticised for crying for an encore long after “Elvis has left the building.” Thisis certainly true of the downgrade of Trinidad and Tobago.
The reality is that the writing has been on the wall for some time. The question is does it really matter?
Well first we must recognise that this is an election year and so the Moody’s downgrade is not welcome news for the incumbent administration.
Second no matter how expected a downgrade may be, the effect of bad financial news tends to be cumulative. Investors’ perceptions about creditworthiness vary incrementally and each time a credit rating moves in the wrong direction the perception moves closer towards a perceived “danger-zone”.
The experience of the United States during a downgrade is an excellent indicator of this point.
When the US lost its AAA rating in 2011 the amount it had to pay to borrow funds actually decreased. This is because investors were nowhere near their perceived “danger-zone” in respect of the US, and in real terms still viewed the US as one of the safest investments in the world.
The experience of Trinidad and Tobago may prove different to the United States. If investors perceive investments in Trinidad as being closer or even within their danger zone it may make it more expensive for the government of Trinidad and Tobago to borrow money in the future.
If this is the case this downgrade will have serious repercussions for us all.

And if you really want to get Moody…

In the United States there are three companies that have higher credit ratings than the Federal Government. These are Microsoft, Exxon Mobil, and Johnson & Johnson. Others companies have had coveted AAA ratings in the past. Enron, Global Crossing, and Bear Stearns to name but a few.
Readers should already be familiar with those names. Proof perhaps that sometimes you have to take things like ratings with a “pinch of salt”.

Closing thoughts – a time to chill and a time to invest?
Firstline Securities Limited offers comprehensive coverage of local and international markets with a bias for the energy sector. Firstline offers a number of unique opportunities to put surplus cash to work either as your asset manager or investment advisor. Please contact us for more details at info@firstlinesecurities.com or at 868.628.1175. We can discuss your investment needs in detail and craft a portfolio that makes sense for you. We look forward to hearing from you.


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