BMI Sovereign Ratings Index Methodology
The BMI Sovereign Ratings Index has been compiled with the intention of giving a clear indication of our view of tradable sovereigns that is as forward looking as possible, and gives a balanced perspective not only of countries’ ability to honour their debt obligations, but, equally importantly, their willingness to do so. We have rated each country for the 2003-2008 period (incorporating both historic and in-house forecasts) in order to be able to assess the evolution of the credit over what is proving to be a crucial period in the development of these emerging economies. The ultimate rating for each country is that for the coming year – clearly, if we see upside or downside ahead, this should be factored into our outlook immediately.
On the Ability to Pay side, we consider key economic indicators, including growth (and its deviation from its long-term trend) inflation, trade, and the level of external debt in relation to GDP and to exports. We also look at the level of foreign exchange reserves, which are of course fundamental to paying external debt obligations, and the primary fiscal balance, which we think is a particularly useful indication of the government’s commitment to take the necessary steps to cover its debt servicing costs. Another important element that we factor in to our ratings is the currency risk on external debt – a sharp currency depreciation would obviously increase both the economic and the political cost of debt servicing, and heighten the risk of default. We also take into account BMI’s own short-term economic risk ratings, which in turn are compiled from an in-depth analysis of a wide selection of key macroeconomic variables.
In the Willingness To Pay section, we dissect the authorities’ attitudes towards their financial obligations. To do this we have considered the extent to which the government has proved itself to be committed to servicing its debt, both in its public pronouncements and in its policy responses. Fiscal policy in particular is closely examined in order to gauge exactly how prudent the government plans to be with regard to making the necessary cut-backs to prioritise debt repayments. Emphasis is also placed upon the extent to which the government has a mandate to enact crucial fiscal reforms, and whether there is policy cohesiveness and agreement in the top levels of government. Our assessment of the credibility of the monetary authorities and monetary policy is also factored in to the rating, in order to assess whether inflation and money supply growth are likely to be kept under control. Obviously, political risk influences the government’s willingness to service its debt, and we analyse the possibility of political turmoil, whether in the form of corruption, changes either within or between administrations, weak governments, or potentially destabilising elections. The latter may well prompt a relaxation of fiscal discipline even if they are unlikely to lead to a hand-over of power. BMI’s short-term political ratings, which quantify domestic political considerations including policy-making capability, succession, public participation in the democratic process, and unemployment, are also factored in to our calculations. Finally, and very importantly, we quantify our own view of the market, which is based on whether we see the market trending higher or lower over the coming year. This view also encompasses not only the outlook for the domestic economy but, in addition, the external investment climate for emerging markets debt, (weighing up conditions including key commodity prices, real global growth, and interest rates).
