On October 18, Moody’s downgraded Italy by one notch and kept its outlook at stable. This was better than feared, leading to a rally in BTPs. Standard & Poor’s is also poised to move the market with its verdict on Italy a week later.
It illustrates yet again how enthralled Europeans are by the rating agencies despite all the talk from the EU during the sovereign debt crisis about how it was going to fix this very problem.
Credit ratings dictate investors’ mandates. And the European Central Bank takes them into account, for example when judging whether to accept sovereign debt as collateral; another reason why private investors pay so much attention.
Private investors outsourcing credit work to the agencies has its risks, but it is their prerogative. The ECB doing so is less understandable.
The overall effect is pro-cyclical: a downgrade leads to a sell-off, which leads to rising yields, worse debt sustainability and further risk of a downgrade. There is also a suspicion that the agencies are unduly influenced by market moves anyway, and thus risk bringing on a crisis.
It is also worth questioning how well the agencies can assess sovereign creditworthiness. Rating an individual company is one thing. A country is different, requiring delicate judgments about decisions made by political parties, individual policymakers and the voting public.
And compared with the last eurozone crisis, the political scene is much more febrile. Economists, pollsters and anyone else you care to name have all called elections incorrectly in recent years. It is not clear why rating agencies could do any better.
The EU has failed. Rating agencies are still as vital a part of financial plumbing as they were. But their views should not be treated as sacrosanct.