The Constitutional Court sent shock waves through financial markets, again, when it nullified the Feb 2 election. Political implications aside, this looks bad for the economy.
Moody’s, one of the Big Three international credit rating agencies, promptly declared that the court’s March 21 ruling was “credit negative”. No surprise: it used “credit negative” last year to describe the government’s rice-pledging scheme as well. Standard and Poor’s has also said it could revise down the country’s rating in light of the political stalemate if the likelihood of widespread and prolonged violence rises.
These remarks point in one direction: Thailand’s rating is at risk.
The ABCD of credit ratings: Credit ratings are essentially opinions about the creditworthiness of a debt issuer: a corporation, a bank, or a sovereign state. Thailand is currently rated BBB+ with a stable outlook by all of the Big Three (Moody’s, S&P and Fitch Ratings). This grade means the country has adequate capacity to meet financial commitments, but adverse business and economic conditions are more likely to impair this capacity.
Political unrest reduces consumers’ confidence, and hence household consumption, while the delay in megaproject investments deters business capital expenditure. Such adverse conditions lower the government’s capacity to collect tax – it missed its target by a whopping 20% for the first five months of the fiscal year – thereby curbing its ability to repay debt, or afford additional borrowing.
Nevertheless, the agencies have already factored these conditions into their decisions – not these specific events of course, but a broad set of adverse circumstances. S&P, for example, looks at five key areas to determine sovereign creditworthiness: political, economic, external, fiscal, and monetary scores. Despite occasional comments about credit-negative developments, all of the Big Three maintain that Thailand’s rating is still consistent with the “definition” of BBB+.
At TMB Analytics, we have a “shadow rating” model to assess ratings for 65 economies based on macroeconomic fundamentals such as GDP per capita, unemployment and inflation rates. On average, our predictions missed the actual ratings by just a bit more than a notch – so we are pretty close in tracking the agencies’ decisions.
According to our analysis, Thailand’s current “shadow” rating should lie between A- and BBB. The agencies’ rating of BBB+ sits in the middle of our range. By comparison, Malaysia is rated A-, the Philippines BBB-, and Indonesia BBB- to BB.
We also experimented by assigning a GDP growth rate for 2014 of zero (the same as in the Bank of Thailand’s stress scenario), which produces a marginally lowered range between BBB+ and BBB, provided that all other key metrics remain unchanged. So far we haven’t seen any sharp deterioration in the country’s balance-of-payments position, or any fast-rising inflation that may stir up economic instability. Indeed, it seems Thailand will be able to maintain its BBB+ rating, at least until the end of 2014.
The last time Thailand was downgraded significantly was after the 1997-98 crisis, when ratings fell to “junk” grade, or below BBB-. A few years passed before the rating crawled back to investment grade again. Current conditions, however, are far different from those prevailing during the Asian financial crisis.
If the sky falls: But what if we were wrong? In a March 6 report, Moody’s outlined five factors that could trigger a negative rating action. We deem one of these factors the most relevant: the extension of the political deadlock into the second half of this year. Now that the Constitutional Court has nullified the previous election, it will take a few more months for another poll to take place, implying that a functional government may not be up and running until August –fingers crossed.
Moody’s mentioned two other notable factors: a severe escalation of political conflict; and the escalation of protests to the point that they have long-lasting effects on tourism or manufacturing. So the risks are there. But none of these events alone may lead to a negative rating action.
A case in point was the chaos of 2009 in Bangkok and Pattaya. Neither Moody’s nor S&P acted on the event. Only Fitch cut Thailand’s rating by a notch, citing the cumulative effect of repeated episodes of political disorder. Further, despite the severity of the 2010 conflict, none of the agencies cut the country’s rating. This time, there has been no dispatch of armed forces, nor have protesters targeted economic assets. This affirms our belief that Thailand’s rating is safe for the duration of 2014.
But if Thailand was downgraded, a rise in borrowing costs will be unavoidable. A rating cut by a notch or two may entail a percentage point increase in the yield of 10-year government bonds. A decline to junk, however, could double (or even triple) interest rates.
Corporations and banks in Thailand would face higher financing costs too. Why is this so when there is no direct link between a country’s rating and those of private entities? Not quite. The agencies generally apply a “sovereign ceiling” – a loosely enforced policy not to rate a private borrower above its sovereign counterpart. There are a selected few exceptions. In Thailand, for instance, Advanced Info Service is rated A-, higher than the sovereign BBB+, given the mobile market leader’s access to foreign ownership and capital.
“Sovereign ceiling” implies that country rating will be an important determinant of corporate ratings, and hence their costs of financing. An IMF paper published in 2007 estimated that a decline of a couple of notches in a sovereign rating could increase corporate bond spreads by 50 basis points. That’s on top of the initial increase in the government bond yield, which is normally a benchmark in indicative pricing.
Indeed, it’s wise to be cautious, but we should not be overly panicked either. Thailand’s robust economic fundamentals warrant that we won’t fall to junk grade in the foreseeable future. Even if political tensions escalate into violence, Thailand should still stay afloat over junk. We just hope that day won’t come.
TMB Analytics is the economic analysis unit of TMB Bank. Behind the Numbers is co-authored by Benjarong Suwankiri and Warapong Wongwachara. They can be reached at tmbanalytics@tmbbank.com
