Articles & Speeches

It Takes Innovative Thinking to Reform the International Credit Rating System

May 18, 2015 04:38 PM Author dagong Font:TTT

Guan Jianzhong

Feb. 16, 2011


The world’s biggest debt system is made up of developed countries and accounts for over 90% of the total amount of the global government debt; using their say in international rating, this debt system is under its control. They assign themselves the highest grade of credit rating against their actual solvency; as they concealed their credit risks for the world investors, they ignited this biggest credit bomb in the globe, ultimately resulting in this unprecedented global credit crisis. It has been more than three years since the eruption of the credit crisis, yet the world has not yet entered the post-crisis era, while the credit crisis is still ongoing along its inherent track, it has evolved from the debt crisis in the financial field to the economic crisis and sovereign crisis in the wealth creation sector, heading for the overall global economic crisis. Since the crisis originated from the disruption of the credit system by the current international credit rating system, to end the crisis should also begin with the construction of an international credit rating system and recovering world credit. The traditional understanding of the cause of the crisis and the measures taken to save the crisis have put the international community in an extremely passive position in dealing with the most serious non-traditional security threat. In order to end this long-drawn-out global credit crisis as soon as possible, we must abide by the essential requirements of the development pattern of the credit economic society, set up innovative thinking to reform the international credit rating system, and speed up the process of building a new international credit rating system that safeguards the security for the international financial system.

I. The development of the world economic situation since the eruption of the crisis increases the urgency for reforming the international credit rating system

The world economic situation in the past three years can be seen as follows:

The fifteen developed debtor countries that account for 59% of the global GDP, namely the US, Japan, Germany, France, the UK, Italy, Spain, Austria, Belgium, Portugal, Ireland, Greece, Iceland Canada, and the Netherlands, are the economies that have suffered the most serious damage by the crisis. In order to rescue the crisis, these developed creditor economies all adopted relaxed monetary policy of nearly zero interest rate and their fiscal stimulus policies were also rarely ever utilized in history. The expected economic recovery has not occurred yet when the means of economic regulation have been nearly exhausted. The aggregate statistics of the fifteen developed debtor countries in 2010 indicate:

(1) The GDP was 42.3 trillion USD, indicating a slight increase of 16.4% only compared with that of pre-crisis 2006; the total volume of government debts was 40.2 trillion USD, showing a drastic increase of 45.1% compared with that of pre-crisis 2006. (2) The total volume of government debts was 94.9% of GDP, 262.2% of fiscal revenues; while in 2006, they were 77.0% and 92.4 % respectively.

In the developed debtor countries, the economic growth fell short of the debt growth, finance was unable to make both ends meet and the government debts rose instead of decreasing, as for the debt income which is the basis of the state operation, the financing cost tended to rise due to the increase in national debt repayment risk. In a word, the driving force to restore the economic growth was not clearly visible in the most developed economies, presenting a gloomy prospect. Under this circumstance, as the world biggest debtor country, the United States, while confronted with the irresolvable sovereign debt crisis, made a reckless move to expedite the running of its banknote printing machine, flagrantly launching a world credit war; such a move will definitely risk triggering an overall global economic crisis.

In comparison, the fifteen major emerging creditor countries and regions that account for 25% of the global GDP, namely China, Russia, Saudi Arabia, Taiwan China, Hong Kong China, India, South Korea, Brazil, Thailand, Indonesia, Singapore, Malaysia, Argentina, Algeria and Iran, though greatly suffered the harm of the crisis, too, their strong wealth creating capabilities demonstrated the ability to withstand the external credit crisis:

 (1) As of the end of January, 2010, the foreign exchange reserve was 5.5 trillion USD, indicating an 89% increase compared with that at the end of 2006. (2) At the end of 2010, the estimated GDP was 15.5 trillion USD, showing a 41% increase compared with that at the end of 2006.  

While maintaining the stability of the international credit system by relying on their own strength, the emerging creditor countries and regions continued to provide funds and commodities in support of the developed debtor countries that suffered the most serious crisis, which helped avoid a complete breakdown of the international debt system. 

The development of the world economic situation since the eruption of the crisis has proved that this crisis is different from any of the previous ones that human society has experienced, that it is the first global credit crisis to happen in the background of credit socialization and globalization. The current international credit rating system takes the debtor’s position, sets up the rating standard that is favorable for debtors by taking advantage of having a say in credit rating, assigns the developed countries the highest grade of credit rating without considering the real solvency of the debtor countries, and conceals their credit risks; consequently the developed debtor economies exhausted their credit capabilities. Thus, such a rating system becomes the root of the deepening and continuation of the credit crisis.

 From the credit ratings of the major creditor and debtor countries and regions assigned by the threeUScredit rating agencies one can see their responsibilities in creating the credit crisis.

Table 1 Comparison of the ratings of the major creditor and debtor countries by S&P before and after the credit crisis (local currency)

No.

Developed debtor country

2006

2010

Emerging creditor country and region

2006

2010

1

TheUS

AAA

AAA

China

A

A+

2

Japan

AA-

AA

Russia

A-

BBB+

3

Germany

AAA

AAA

Saudi Arabia

A+

AA-

4

France

AAA

AAA

TaiwanChina

AA-

AA-

5

TheUK

AAA

AAA

Hong KongChina

AA

AA+

6

Italy

A+

A+

India

BB+

BBB-

7

Spain

AAA

AA

South Korea

A+

A+

8

Austria

AAA

AAA

Brazil

BB+

BBB+

9

Belgium

AA+

AA+

Thailand

A

A-

10

Portugal

AA-

A-

Indonesia

BB+

BB+

11

Ireland

AAA

A

Singapore

AAA

AAA

12

Greece

A

BB+

Malaysia

A+

A+

13

Iceland

AA

BBB

Argentina

B+

B

14

Canada

AAA

AAA

Algeria



15

Netherlands

AAA

AAA

Iran



Note: S&P has not ratedAlgeriaandIran.

The US undisguisedly violated the interests of the world creditors by the so-called quantitative easing monetary policy, which not only reflects the collapse of its real national solvency, but also indicates the dramatic decline in the government's willingness to repay the debts. An international CRA should respond to this move, and it is another test to the existing international credit rating system. However, the three US CRAs chose to be silent, supporting the US government to plunder the interests of creditors by manipulating the right to issue international reserve currency. Such international CRAs have completely betrayed the interests of international investors, proving once again that they are faithful representatives of the interests of the biggest debtor country.

From the analysis of the entire process of the crisis, we find such a law: the credit system which consists of creditors and debtors constitutes the economic basis of the modern society, whether the CRAs can correctly reveal the default risks of debtors concerns the security of the credit system; social funds cannot start to flow efficiently unless the creditors are confident in the investment when credit ratings make objective and impartial judgment of the credit risks of debtors. If we make no change to this way of thinking to perceive the nature of the crisis, if we continue to cherish fantasy about the existing international credit rating system, if we don’t take action to build a new international credit rating system, human society will have difficulty choosing the right roadmap for economic recovery. Undoubtedly, this would result in the repetition of the previous mistakes.    

Dagong Global Credit Rating Co., Ltd. has been actively promoting the reform of the international credit rating system and launched its important research results of the past five years on 11 July 2010, namelyNew Sovereign Credit Rating Standardand credit ratings of 50 countries. This event changed the pattern of international credit rating system, promoting the international credit rating development toward a rational direction. Within half a year after Dagong issued sovereign credit ratings, Moody’s, Stand & Poor and Fitch adjusted 12 times their rating grades for 10 countries and these adjustments converge to the ratings assigned by Dagong, which further demonstrates the impartiality of Dagong’s credit ratings.  

Table 2 indicates the convergence of the sovereign credit ratings by the three CRAs toward Dagong ratings since 11 July 2010 (on local currency)

Table 2 The adjustment by threeUSCRAs following Dagong ratings (local currency)

Country/region

Dagong

Adjustments by three CRAs

Rating grade

Rating time

Rating grade change

Time of adjustment

CRA

Argentina

B

2010.07.11

Upgrading to B from B-

2010.07.12

Fitch

Portugal

A-

2010.07.11

Downgrading to A1 from Aa2

2010.07.13

Moody’s

Estonia

A

2010.07.11

Upgrading to A from BBB+

2010.07.19

Fitch

India

BBB

2010.07.11

Upgrading to Ba1 from Ba2

2010.07.26

Moody’s

Ireland


2010.07.11

Downgrading the outlook to negative from stable

2010.07.30

Moody’s

Russia

A/stable

2010.07.11

Upgrading the outlook to positive from stable

2010.09.08

Fitch

Argentina

B

2010.07.11

Upgrading to B from B-

2010.09.13

S & P

Spain

A

2010.07.11

Downgrading to Aaa from Aa1

2010.09.30

Moody’s

Hong KongChina

AAA

2010.10.21

Upgrading to Aa1 from Aa2

2010.11.11

Moody’s

China

AA+

2010.07.11

Upgrading to Aa3 from A1

2010.11.13

Moody’s

Ireland

BBB

2010.12.06

Downgrading to BBB+ from A+

2010.12.09

Fitch

Ireland

BBB

2010.12.06

Downgrading to BBB+ from AA

2010.12.20

Moody’s


II. The guiding principles of reforming the international credit rating system


To reconstruct the international credit rating system, attention should be given to drawing lessons from the global credit crisis, following the development patterns of credit economy and credit rating and taking the holistic interest of human society into consideration; the fundamental principles are as follows:

1. The globality principle. The internationalization of risks triggered by globalization of credit makes it extremely likely to escalate a local credit risk into a systematic risk, which, after quickly spread, might start a worldwide credit crisis. Therefore, how much the credit risks are disclosed in each country is closely connected with the credit security of other countries; the credit rating system in every country should be an integral component of the global credit rating system. Objectively speaking, in the time of globalization of credit risk information, it is impossible for a CRA in any country to independently own the credit information for risk analysis, and this alone will affect the precision of credit rating. The credit system had integrated human society into an entirety; every country or societal member constitutes a joint of the global credit chain. Every member who assumes the important historical responsibility of constructing the new international credit rating system should plan the international credit risk management system that can truly guarantee the safe development of humankind from the global perspective.  

2. The independence principle. The duties of the international credit rating system are to resolve the problem of risk information asymmetry that is exacerbated in the process of credit globalization, to provide early warning of credit crisis and to safeguard the security of the international credit system; the independence of the international credit rating system is the prerequisite to fulfill this mission. The independence that is emphasized here refers to the non-national character, non-profit-orientated character, non-political character, non-competitive character, and impartiality of the international credit rating system.

Non-national character. The international credit rating system represents the interest of all the members of the international community, instead of satisfying the interest appeal of some countries; it should never be controlled by certain countries; thus, ultra-sovereignty status is the precondition for constructing the new international credit rating system.

Non-profit-orientated character. CRAs are the carrier of the international credit rating system. A CRA is not an ordinary market player, its foremost responsibility is to maintain the public interest, and it should not be the agent of some interest groups. Certainly a CRA is an enterprise, so it should be profitable to maintain sustainable development like an ordinary enterprise; however, its own interest should be pursued when the public interests are guaranteed, which should be realized by design of the system’s mechanism.  

Non-political character. The international credit rating system discloses risks via sustained study into the evolution patterns of factors of credit risks formation; never should some ideological factors and values be utilized as causes for measuring and judging credit risks, otherwise ratings would become a tool of a political group, which would lead to a disastrous consequence.   

Non-competitive character. History has proven that trying to require the credit rating system to perform the public responsibility through a competitive system would result in competition in rating grade and price that damages the investors’ interests and become the trading terms between CRAs and issuers. Thus, credit rating must be a government-chartered business recognized by the market, it should by no means be a product of free competition of the market. At the same time, the regulatory authorities should design the development objective of a rating standard for CRAs, encouraging the CRAs to compete in rating technologies, so thatsuperior enterprises will prosper and inferior ones be eliminated. 

Impartiality. With ensuring conditions of a correct rating system mechanism a series of regimes such as technical and professional codes should be implemented to constrain the behavior of CRAs, so that they will perform their functions impartially. 

3. The consistency principle. Credit rating standards is the core component of the international credit rating system; it is only through studying the particularities of factors of credit risk formation that an internationally unified credit rating standard can be established and accurate risk comparison can be made. If the consistency principle on credit rating standards is not observed, there will be no way to form a consistent rating language; consequently it will be difficult to realize the globalized application of the credit rating information. 

4. The international regulation principle. An international credit rating regulation system should be established, and unified regulatory rules and specifications should be developed; national regulation cannot substitute for international regulation and national regulation must be subject to international regulation.

III. Exploring the new international credit rating system model

I delivered a speech entitled Constructing New International Credit Rating Systemon Bo’ao Forum in April 2009; looking back I think the logic in conceiving the new international credit rating system model remains rational. It is still necessary to continue exploring the credit rating system model that is coming into being when the idea of reform is becoming a world mainstream consciousness. 

The new international credit rating system consists of three parts, namely an international credit rating regulatory organization, an international credit rating agency and an international credit rating standard.

1. The international credit rating regulatory organization. Within the International Organization of Securities Commissions, “International Credit Rating Regulatory Commission" can be created, which should be made up of the national credit rating regulatory body in each country. This organization should be responsible for planning the development of the international credit rating system, working out global regulatory rules over credit rating, giving guidance to the construction of regional credit rating systems, normalizing the behavior of CRAs, and promoting the upgrade of credit rating standards. This commission should be governed by the world creditor countries.

2. The international credit rating agency. This organization is composed of the CRAs recognized by the government of each country, responsible for: setting unified international rating standards, rating on multi-national institutions, participating in the rating business in every country so that a dual rating mechanism is established for each country, aiming at checking and preventing credit rating risks.

3. The international credit rating standard. Rating standard is directly related with the rationality of rating results, so the construction and management of rating standards should be incorporated in the rating system. Under systematic and scientific planning supervision of rating standards is carried out by CRAs, instead of being performed by the CRAs on their own accord. The international credit rating regulatory organization can formulate the rating standard development plan, encourage CRAs to implement and improve. The international CRA should focus on setting up and improving the credit rating standard, which is guaranteed by the system’s mechanism.

Determined by the inherent development pattern of the credit crisis, 2011 will remain an eventful year, multiple uncertainties of the world debtor economies will push the global credit crisis to spread even further. CRAs with a sense of social responsibility should take action and achieve something to help the human society ultimately get rid of the calamity of credit crisis. Then it will be the best reflection and summary of the global credit crisis as well as a milestone for the mankind to explore the development laws of a credit economic society to expedite the reform of the international credit rating system and build a new international credit rating system that reflects the development laws of credit economy and rating; one that can assume the responsibility of safe development of overall human society. This is the common expectation of the human society, and no doubt, this goal will be achieved.