UK's Credit Rating: Why Does Losing It Matters!



UK's Credit Rating Matters Hugely!

According to the three major rating agencies, Moody's, Fitch and Standard & Poor's, Britain is one of only 11 countries with a AAA credit rating. UK's credit rating looks safe . . . for now.

Along with Australia, Denmark, France, Germany, Luxembourg and the United States, the UK may not face a credit rating downgrade in the (not so distant!) future.

Despite the three major credit agencies having lost (some of) their credibility as a result of them not (soon enough) downgrading credit ratings of Governments and company’s debts, during the last two years, what they say can’t be ignored. In certain quarters, they still have a huge impact.

UK's Credit Rating at Risk!

Moody's, one of the three main rating agencies that assesses the strenght of a country's public finances, announced on February 14th, 2012, that Great Britain could lose its AAA credit rating beacuse of the weakening health of the economy and exposure to the Eurozone debt crisis.

Moody has changed the UK's outlook to negative from stable. This means that the possibility of a credit rating cut has increased. Britain now shares the same outlook from Moody's as the USA and France.

Other rating agencies are negative on UK's Credit Rating!

Dagong rating agency of China

Late May, 2011, Dagong cut UK's credit rating. The downgrade from AA- to A+ puts Britain on a par with Chile and heavily-indebted Belgium, and the US, which Dagong downgraded in November, 2010. Dagong kept a negative outlook on the UK's rating, suggesting that more downgrades may be yet to come.

The downgrade reflected "the deteriorating debt repayment capability of the UK and the difficulty in improving its sovereign credit level in a moderately long term in the future."

Uncertainties arising from the Bank of England's future monetary policy and the impact of debt-laden European countries on the British financial system are "likely to further worsen the government's fiscal status", it said.

Weiss Ratings

Early May, 2011, independent ratings firm Weiss Ratings released its first-ever ratings on 47 countries.

Weiss Ratings identified 13 countries as having "good"(B) or "excellent"(A) financial stability. And the United Kingdom is not one of them (C- = fair, negative).

Weiss Ratings criteria include factors such as debt, global stability, macro economic factors and borrowing ability.

It may come as a surprise that none of the countries mentioned above secure an "A" rating at Weiss's. Instead, China is ranked first, while several other growing Asian nations also ranked very high, including Thailand, South Korea, and Malaysia. Switserland is the only Western European country with an A rating.

Dagong's ratings are not widely relied on by investors outside China. While US-based Weiss Ratings has only recently started to rate souverein nations.

Dagong - founded in 1994 - rates China AA+, three notches above the UK and US, and much higher than the People's Republic is ranked by the three western agencies.

Nevertheless, Dagong's and Weiss Ratings may offer a more impartial view of UK's credit rating and the true health of government finances in Europe and North America.

Why did Britain have to pay higher interest rates to borrow money?

For instance, by the end of February 2010, Britain’s 10 year Government Bonds (“Gilts”) yielded a full percentage point higher than Germany’s ten year bunds (the German equivalent to our Gilts).

Partly because Britain is having to compete for money against a number of other governments which are also running substantial budget deficits. A UK credit rating downgrade would make this a much harder exercise to complete.

Because investors will need to be persuaded that Britain will not attempt to:

  1. inflate its way out of the current budget deficit, and/or
  2. devalue Pound Sterling.

Worse still, international bond investors such as Bill Gross, who runs the world’s largest bond fund at Pimco, forewarned us, earlier in January, that:

“high debt, with the potential to devalue its
(" Britain’s") currency, presents
high risks for bond investors”

In other words, if other national and international Government Bond purchasers are of the same opinion -and UK's credit rating is downgraded- and, act upon that, the short term future is indeed grim.

The short-term end result . . .

Nobody would want to hold our Gilts or purchase more at current yields!

A UK credit rating downgrade would make matters only worse. Interest will have to rise in order to attract the billions required to finance the deficit.

Worse Case Scenario?

As we have seen before, unchanged credit ratings are not a guarantee that something is not going to explode on you.

Even if you accept that investment grade Gilts are more creditworthy than most other forms of debt, there is still one more major risk … the fact that a prolonged recession could bring down all economies, even the very strongest.

A weak Government operating with a hung parliament in 2010 is one of the worse things that can happen to us currently.

Why?

The process of ongoing credit ratings downgrades can turn into a vicious cycle.

In other words, a rating downgrade and an ensuing inability to borrow more money may lead to an even weaker country (or business) and further credit downgrades.

As such, both investors in shares as well as bond investors should take credit ratings seriously, even those who own shares in the issuers of the bonds instead of their bonds.


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