Perspectives 2019 2020 Public Sector

Citi Perspectives 21 Another hard-to-change rating factor is a country’s currency status in world markets, a variable that falls along a spectrum between reserve currency and, in “dollarized” economies, having been replaced by external cash. Where a country’s currency falls along this spectrum has a profound impact on rating outcomes in all three methodologies, but each treats this factor quite differently. Only Fitch includes direct quantification. With reference to the IMF Currency Composition of Official Foreign Exchange Reserves (COFER) database, the Fitch model calculates the share of global reserves held in each of eight currencies, a figure that is given a weight of 7.9% in the “home country’s” rating model. 7 The U.S. Dollar’s 61.7% share of allocated global reserves adds 4.2 points to the USA’s quantitative score; in the model, total scores above 15.5 suggests an AAA outcome, and so the exorbitant privilege of minting the U.S. Dollar is reflected also in the country’s credit rating. 8 In contrast, countries without a reserve currency have a score of zero for this variable. Fitch’s rationale for the high weight given to the currency status variable — the fourth highest of 18 — is that the global demand for reserve currencies insulates home countries from normal external funding pressures. Such insulation of course also impacts other parts of a sovereign credit profile. As Fitch writes, “[Reserve currency status] benefits fiscal as well as external financing flexibility as the majority of reserve assets are government bonds.” 9 It follows that both direct and indirect reference to reserve currency status appear throughout each of the agency methodologies. Moreover, the models are sufficiently nuanced to capture the benefits of external currency demand even when that currency does not appear in COFER. For Fitch, one example is a measure of foreign exchange and gold reserves that is applied only to non-COFER countries. Currency status is an input into two key parts of the S&P model: the Monetary and the External Assessments. In the former, a score between one and six is matched to the currency regime. A lower score is preferable, and reserve currencies are given a one; free-floating currencies two; managed floats three; conventional pegs or regimes with heavy intervention four; hard pegs five; and “dollarized” systems six. This score is 40% of the Monetary Assessment, which is one of the five components that combine to produce the indicative rating. In parallel, the External Assessment computation divides countries into different currency status groups and treats each distinctly. Prior to qualitative adjustments, reserve currency sovereigns cannot score worse than three of six regardless of their levels of external debt, and sovereigns with “actively traded currencies” (those accounting for more than one percent of global annual foreign exchange turnover) cannot score worse than four. 10 Other sovereigns do not have a floor on their external financing vulnerability assessment. 11 The Moody’s treatment of currency follows a similar logic, reflecting that currency regimes and external currency demand are simultaneously signals of institutional strength, monetary policy credibility and capital markets health as well as being drivers of other credit-positive sovereign attributes, such as having strong access to financing. Therefore, an in-demand, free-floating currency is a clearly valuable asset to sovereigns from a credit rating perspective, but it is no mean feat for a government to upgrade its currency status. Between 2001 and 2016, China’s RMB was the only currency to become a new reserve currency, and only six currencies climbed above the 1% “actively traded” threshold. 12 While countries with dollarized and hard-peg currency regimes will be rewarded for steps towards liberalization, it is less obvious what policymakers in countries with floating, small-circulation currencies might do to improve their performance on currency status metrics. Currency status is an input into two key parts of the S&P model: the Monetary and the External Assessments. 7 The AUD, CAD, CHF, EUR, GBP, RMB, USD and JPY. All Eurozone countries are given the benefit of the Euro’s c. 21% share of global reserves, but “makes adjustments in the Qualitative Overlay (Fitch’s qualitative component) to recognize that not all countries in the Eurozone have the same degree of Reserve Currency Flexibility.” Fitch (2019), “Sovereign Rating Criteria, Master Criteria,” 24. 8 As of 4Q18. IMF Currency Composition of Official Foreign Exchange Reserves, data.imf.org . 9 Fitch (2019), “Sovereign Rating Criteria, Master Criteria,” 24. 10 As measured in the Bank of International Settlement’s (BIS) Triennial Survey of foreign exchange and OTC derivatives trading, www.bis.org/statistics. As of the most recent survey (2016), 15 currencies meet this threshold and are not COFER reserve currencies. 11 S&P (2017) “Criteria: Sovereign Rating Methodology,” 12-15, 27. 12 The Brazilian Real, Indian Rupee, Polish Złoty, Russian Ruble, Taiwanese New Dollar, and Turkish Lira. BIS, Triennial Survey.