LETA, 5 April 2007

I shall try to explain how I understand what the international rating agencies are offering. Who needs such a rating (for a country, a factory, or a bank), and what is it, anyway? In my opinion, it is simplest to explain a rating as an opinion on something. In our case, it is the opinion of Fitch Ratings on the current state and future development of the Latvian economy. Namely, a downgrade from a stable outlook (nothing will significantly deteriorate in the future, but nothing will improve either, thus, it will remain unchanged) to a negative one (there are preconditions that may force a change of opinion (rating)). So, the product offered by rating agencies is an opinion. Like any opinion, it cannot be standardised, so, in my view, it is not worth getting bogged down in polemics about whether an opinion is right or wrong. That is not an argument, though we could certainly have a broad polemic about those. A rating agency’s opinion differs from my own in that mine is, in principle, only interesting to me. The agency’s product is interesting to others, too. It is essential for a relatively wide range of consumers, and these consumers are prepared to pay for the existence of an opinion-maker simply because it regularly expresses its opinion. These consumers are, first of all, those about whom the opinion is expressed, for example, Latvia or a specific bank which might not even need such a rating itself, but the rating is required because it is used by investors when making decisions about that bank. In turn, Latvia, another country, or a business needs investor money to finance daily needs and growth. Thus, the agencies' opinion is necessary for those who have to borrow money on the international money market and who, for this purpose, either issue securities or borrow in other ways (e.g., syndicated loans, which, in simpler terms, is a collection organised by one person that is later lent as a single large pool of money to whoever needs it), and these borrowers pay the rating agency regularly for the preparation of the rating. In conditions where there are a great many people who need money, it is increasingly difficult, not to say impossible, for those who have the money to lend it as safely as possible and to track all the opportunities. Therefore, the big and wealthy entities that lend money act rationally and, for these needs, do not pay a regular salary to a large, highly educated staff of analysts, but instead choose to use rating agencies, to which they pay a fixed one-off fee or a subscription. So, secondly, the product is also needed by those who lend money, to facilitate the decision-making process. There are also situations where rating agencies manage (or have the audacity?) to receive payment from both sides for the very same opinion. To summarise what was said previously, rating agencies are commercial companies of well-educated and well-paid men and women who, for a certain reward, sell others an opinion about themselves or about other persons. Moreover, what is sold is an opinion about which it is impossible to objectively state that it is right or wrong – it is what it is, and one can only believe or disbelieve it, accept or reject it. If I may be forgiven, there is a similarity here to religion – you either believe in God or you do not, and it is pointless to engage in proving His existence or non-existence. Historically, it has transpired that in the “opinion market” (please do not confuse it with the “hypocrisy market”) there are three significant and particularly notable characters (agencies) – Standard & Poor’s, Fitch Ratings, both of which have announced the possibility of downgrading their opinion of the Latvian economy, and Moody’s, which has maintained a positive outlook. Why is that, if everyone was analysing the very same subject? Again, because it is a matter of opinion, not an objective assessment based on uniform standards that can be measured by quantitative or even qualitative indicators. Each of these agencies has its own methodology (which, however, does not differ significantly), by which it arrives at one opinion or another, which it then announces to its consumers. The activities of these agencies are not monitored by state structures; rather, the agencies are self-regulating organisms that, like free-shooters, fire at targets of their own choosing (though more often, the target steps in front of the shot itself and even pays for the shot, which is not always just a gentle and soothing low-current shot used in physiotherapy) and use their own calibrated ammunition. Nevertheless, the agencies sell an opinion, and it is important to them that it coincides as often as possible with the actual state of affairs, especially looking towards the future – in other words, that the fish is more often of first freshness rather than starting to smell, because soon no one will buy such a product. Often there are cases when rating agencies downgrade ratings when it is already clear to any mortal without the agencies that the issuer is in trouble and the money has vanished beyond recall. The thing is that rating agencies cannot follow all issuers every day, and therefore the rating, which will be used for some time in the future, is assigned by analysing past events. A thankless occupation... We know ourselves that if a construction brigade has built 15 previous projects well, it does not at all mean that they will build the sixteenth just as successfully, if they build it at all. So then, to protect themselves as much as possible against potential mistakes, every rating agency has a weapon in its arsenal like a future outlook. This future outlook is like a fig leaf to cover one’s shame if, in the event of the death (financial collapse) of a patient (to whom a rating was assigned), someone says – why on earth had you counted the dead among the living! A thoroughly convenient solution for everyone, because the forecast can be used when setting the price for a loan, or to make a decision not to invest and give the money to someone else who has the same rating but a better future outlook. It is clear that, in expressing an opinion, the agencies do not claim to tell the person about whom this opinion is expressed what they must do to change that opinion. They merely inform of their concerns, for example, that the country is importing more goods and services than it is exporting, or that the country has too high an inflation rate and its citizens are spending more than they are working for with their own two hands, furthermore spending “disproportionately” more – again, it is difficult to measure and prove when this “disproportionately” has set in and when it becomes “proportionate”. Whether to listen to it or not, whether to do something or not to mitigate these anxiety-inducing factors, is up to each person to whom the rating has been assigned. According to well-known theories, if someone is downgraded or someone expresses an assumption that they will be downgraded, then in the best case they face higher borrowing costs, but in the worst case, lenders will demand their money back, or “pull out” and bolt away at such speed that not even their heels will be seen. Cases in Asia, Mexico and elsewhere are mentioned as examples, and all the signs suggest that there is grounds for this in Latvia as well. I am convinced (contrary to various studies) that Latvia is, if not an international, then at least a regional financial centre. However, it must be admitted with bitterness that short-term financial investors are not widely represented in Latvia; they are always the first to tip their hats and leave, and with them, the financial system collapses. Namely, thanks to our entrepreneurs’ resigned attitude towards raising resources through the issue of various public financial instruments, which could potentially be purchased by financial investors through the stock exchange, no one will really run anywhere for the simple reason that there is no one to run. Our entrepreneurs’ unwillingness to share any part of their property, for instance with minority shareholders, has turned out to be our advantage. Due to this coincidence of circumstances, Latvia mainly has strategic long-term investors who might even want to run somewhere, but there is nowhere to go and it is not so easy, because running away means sawing off the branch one is sitting on. Real problems for our capital flows in a completely open economy are only possible if financial turmoil begins not even in Europe, but at a much more global level. And no rating agency will predict the arrival of such a moment. Here I am not speaking about the thoroughly real possibility that, due to interest rate fluctuations and the rising cost of credit, some may, as a result of their own not-fully-thought-out actions, have a real need to return to less chic means of transport, for example, walking on foot, and changing a well-furnished home bought with a mortgage. That, of course, is an individual tragedy, but not a state crisis that all taxpayers must solve. An anecdote known in financial circles, I think, quite succinctly characterises the relationship between rating agencies and the users of their products. A financial analyst (rating agency) and a broker (who uses the rating agencies’ services) meet at the lift doors. The broker asks in a very biting tone: “Now surely you will be able to tell me clearly and unambiguously – are we heading up or down?” Some might ask, if financial experts are telling anecdotes about this situation, then perhaps it is not worth worrying about ratings; let us roll forward, it will all be fine, right? There is no need to worry, because anxiety creates haste, and in haste, one can only create trouble and mistakes. For example, in such haste and a desire to be smarter than others, one could write an article or a short message and tell everyone that the lats is going to be devalued. Or, with the pain of the whole world on one’s face, say – if the government, the Bank of Latvia, and other Latvian institutions do not do something, then we all have very little time left to fulfil our dreams... Although one does not have to strain too much to find information that Latvia experienced very good years in its economy with a lower rating than it has now, because just like now, there was relatively high inflation and a current account deficit. In such conditions, it seems, the most important thing is not to overdo the state-level regulation of economic processes. These regulations are easy to introduce, even easier to get used to (who does not like it when someone else figures everything out for them and takes responsibility for it too), but very difficult to repeal, even when it is obvious that they are hindering the dynamic development of the economy. No one has cancelled the cyclicality of economic development, and the opinion of rating agencies reminds us of it once again. Nevertheless, there are things that should be done both at the state level and in everyone’s own household, namely, to reduce expenditure and consumption. The state has committed to doing this, and there is no reason to believe that it will backtrack on this commitment. However, it is desirable to restrict consumption reasonably, rather than eradicate it as a foreign body in the economy. If there is no growing consumption, then what will drive the economy? Capitalism cannot exist without growing consumption; producing for the sake of production is characteristic of a different socio-economic formation. Thus, there is no cause for anxiety, but there is reason to sit down and think about what to do so that the perception, or opinion, about us changes. It so happens that we exist, after all, in the opinions of others about us, and in this specific case – in ratings.
Article first published in the May 2007 issue of the magazine Rīgas Laiks