Perspectives 2019 2020 Public Sector

Citi Perspectives 23 What might be surprising to sovereigns is the weight given to the economic size variable in the methodologies. In the Fitch model, “Share in world GDP” has a 12.8% weight; Moody’s nominal GDP metric is 25% of the Economic Strength component, which is itself one of four components (that do not aggregate arithmetically); and S&P, as described above, allows a significant downward adjustment for small economies. Also surprising is that geographic size, although not directly measured by the models, compounds economic diversification considerations — especially if the small land area exposes the sovereign to natural catastrophe risks. Chart 2 shows that there is no correlation between rating and area alone, but as Fitch remarks, “The smaller a country, the higher the potential impact of an idiosyncratic natural disaster or severe exogenous shock.” 19 Numerous studies have found a physically concentrated economy is more vulnerable to localized catastrophes, such as earthquakes or storms, and the other models similarly link size, diversification and credit risk; as Moody’s notes, “A very small, but very rich country can be subject to an abrupt change of economic fortune.” 20 While we do not wish to suggest that geography is destiny, economic size and location are significant factors in a rating score. When comparing any relatively smaller economy prone to storms or earthquakes, such as the Dominican Republic (BB-/ Ba3/BB-), to larger countries with the same rating (e.g. Russia), the smaller country is compensating for size and location structural penalties by outperforming in other areas. Identifying and publicizing the areas in which a relatively smaller sovereign can outperform larger peers is a key debt management and investor relations responsibility. Partnering with Citi to Address Vulnerabilities Unfortunately, Citi cannot erase past defaults, create a new reserve currency nor enlarge your country, but our expert advice and services address the concerns underlying the hard-to-change variables. For example, regular liability management and debt smoothing reduce the risk of spikes in debt service costs and acute liquidity shortfalls. Liability management exercises are also an opportunity for sovereign issuers 19 Fitch (2019), “Sovereign Rating Criteria, Master Criteria,” 12. The linear regression of size against Fitch rating as a small correlation coefficient (r = 0.12) and it is not statistically significant (p = 0.27). 20 Alano, E. and Lee, M. (2016), “Natural Disaster Shocks and Macroeconomic Growth in Asia: Evidence for Typhoons and Droughts,” ADB Economics Working Paper Series, 503; IMF (2013), “Macroeconomic Issues in Small States and Implications for Fund Engagement,” IMF Policy Paper; Lee, D. et al (2018) “The Economic Impact of Natural Disasters in Pacific Island Countries: Adaptation and Preparedness,” IMF Working Paper, 18/108; Moody’s (2018), “Rating Methodology: Sovereign Bond Ratings,” 10. 21 Moody’s (2019), “Request for Comment: Proposed Update: Sovereign Bond Ratings,” 24. to meet with global investors and demonstrate a commitment to transparency and communication of sound policies. Fortunately, the agencies have discretion over final ratings and might treat a strong liability management program as compensation for past defaults. Moody’s explains this flexibility in its proposed new methodology, “The magnitude of the negative adjustment [for historical restructuring] typically depends on our expectations for the risk of re-default…. We may reduce the negative adjustment if it is clear that the underlying economic, financial or political problems… have been resolved in a sustainable way.” 21 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% % of World GDP AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ CCC CCC- CC C Investment Grade High Yield Chart 1: Percent of world GDP against Fitch ratings Source: Fitch Sovereign Data Comparator (2019) _ 0.50 1.00 1.50 2.50 2.00 3.00 Size (mm sq km) AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ CCC CCC- CC C ( ) * +& +' +( +) +* '& Chart 2: Sovereign land area against Fitch ratings Sources: Fitch Sovereign Data Comparator (2019) and the CIA World Factbook (2019)