Crises need not downgrade: IBCA

Crises need not downgrade: IBCA

JAKARTA (JP): The London-based rating agency IBCA said
yesterday that systemic banking crises do not of themselves
automatically imply sovereign downgrades: much depends on the
scale of the problem, the manner in which governments bail out
banks and the initial financial strength of the sovereign.

The rating agency said in a statement released here that as
far as the long-term foreign currency rating is concerned, if the
government were to assume all the external debts of the banking
system, this would not amount to any change in the overall
sovereign debt burden, but simply a change of obligor.

The following is the main points raised by IBCA in its latest
assessment of the banikng sectors in several Asian countries:

Since IBCA looks at the total non-resident debt claims on a
country in assessing the sovereign rate, this in itself does not
imply a substantial difference in position.

However, systemic banking crises invariably go further than
this and often entail blanket provisions for non-performing local
currency lending and a recapitalization of banks. Simply printing
money to bail out banks may prove highly inflationary and risks
triggering large-scale capital flight, as Venezuela discovered to
its cost.

Timely infusions of liquidity through proper channels, coupled
with a program to exchange non-performing loans for government
paper, are likely to prove much more satisfactory. It can also
allow the authorities to spread the cost of higher domestic debt
service over time, particularly if existing levels of public
indebtedness are high. The cost of bailing out Mexico's banks has
been variously quoted at 8 percent to 12 percent of GDP but, to
date, the government has spent a fraction of this.

In the case of Korea, Bank of Korea was slow to respond to the
shock waves passing through the banking system following the
collapse of Hanbo at the beginning of the year, preferring to
maintain a hands-off approach. That approach has now been
supplanted by a package of special loans to the worst affected
banks, a state-administered fund to buy back problem loans and
assurances to foreign creditors that troubled financial
institutions' external liabilities will be honored.

The assurance to foreign creditors is backed by Korea's
cautious foreign public debt policy.

Likewise, Korea's long track record of budget surpluses,
coupled with gross public indebtedness of less than 10 percent of
GDP, put the sovereign in a strong position to support the
banking system. Even in IBCA's worst case scenario, the agency
believes the public debt/GDP ratio would remain below 20 percent,
far short of similarly and more highly rated sovereigns.

The case of Indonesia is different. The conduct of fiscal
policy has long been governed by the balanced budget rule which
requires the authorities to match current expenditure to current
revenue. To the extent that capital expenditure exceeds public
saving this must be funded from external borrowing: there is no
provision for the government to issue domestic debt and no
opportunity for it to monetize deficits. The scope for bailing
out the banking system using domestic resources is therefore very
limited, necessitating additional foreign borrowing, hence the
recent IMF package which has allowed the government to close 16
banks.

Thailand's case is similar to Korea's in the sense that it too
has low gross public debt and the freedom to issue larger
quantities of domestic public debt. However, the scale of the
problem is likely to be greater in Thailand in light of the
sharper depreciation of the local currency and the impact that
this will have on the baht value of foreign currency debt
service.

Nevertheless, the main risk in Thailand remains the lack of
political will to take the necessary measures to restore
macroeconomic balance and to reform the financial system. On
financing, official international support has been substantial.

International bond issues are probably out of the question for
the time being, but the sovereign's credit standing is probably
still sufficiently good to raise medium- and long-term money from
foreign banks, while further regional help could be available.
However, public sector borrowing abroad to bail out ailing
financial systems without improved financial supervision and
regulation would put a severe strain on investor confidence.