Standard and Poor’s on Thursday, May 21 2009, issued the following statement: “Standard and Poor’s has revised the outlook on the United Kingdom to negative from stable. — The AAA’ long-term and A-1+’ short-term sovereign credit ratings were affirmed. — The outlook revision is based on our view that, even factoring in further fiscal tightening, the U.K.’s net general government debt burden may approach 100% of GDP and remain near that level in the medium term. ”
Is this good news for the UK or bad news? Both the UK’s long-term sovereign credit rating (reflecting the probability of sovereign default in the medium and long term) and its short-term sovereign credit rating (reflecting the probability of sovereign default during the next year) remain at the highest possible levels, AAA and A-1+ respectively. However, the negative outlook is bad, even if it is not bad news. Based on past behaviour, there is a one-in-three chance of a sovereign moving from a negative outlook to a one-notch downgrade.
The fact that one of the three leading credit agencies is publicly hinting at less than complete confidence in the solvency of the British sovereign is not in and of itself terribly significant any longer. Following their incompetent and deeply conflicted performance in rating structured products, the credibility of the rating agencies is badly impaired even in those domains – sovereign debt and the debt of large corporates – where they have not made complete asses of themselves.
Even though the credibility and reputation of the rating agencies is in tatters, the fact that they have not yet been written out of the regulations and rule books governing the investment behaviour of many institutional investors means that a downgrade would still affect market demand for UK sovereign debt. This will probably raise the funding cost of the UK sovereign somewhat.
But even without the input from the rating agencies, it would have been clear that the UK is about to exit its AAA status. It shares this fate with most of the other G7 countries. In two or three years, Canada may be the only G7 country left to have an AAA rating. France could conceivably join Canada. There is nothing too shocking about this. Not that long ago, Japan’s sovereign rating was on a par with Botswana’s (I thought that was rather unfair on Botswana).
I will expand on the case of the UK in what follows, saving a more detailed consideration of the US fiscal predicament (which is much worse than that of the UK) for a future post.
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