The Sunday TimesBusiness

05th May 1996




Are rating agencies always correct ?

By Asantha Sirimanne

Since the advent of the Vanik debenture issue, the role of the rating agency has come to the fore. The lack of a rating agency was one of the weapons used by critics of debentures to discourage prospective investors.

"The rating is not a magic wand that instantly makes a debt issue safe for investors", says a securities analyst at a leading brokerage in Colombo. "Rather it provides a guide for investors to determine how much interest should be demanded from any particular issuer."

"In the very basic sense, the rating agency will convey the issuers ability to repay the debentures and pay the interest", says Dr. Anush Amarasinghe of Crosby Securities.

"Obviously this will make prospective investors more confident, that is why ratings are sought. But of course the danger is that you may also get bad rating", he says.

The Asiamoney magazine for example in its March 1996 issue suggested that rating agencies were not all that hot, at least in Asia.

It quoted a UK-fund manager as saying that Moody's Investors Services, a leading Western rating agency was, "missing something and was naive in its understanding of Asia". In addition he also felt that some of its ratings did not reflect the true potential for default among issuers.

The magazine cites an instance where an Asia Central Bank was effectively blackmailed into co-operating with a rating agency after it was threatened with a lower rating. "We flew them in, paid for their accommodation, sat through long sessions with them, fed them and waited anxiously for their revised rating", it quoted a central banker as saying.

A top official of the Hong Kong Monetary Authority has expressed concern over unsolicited ratings, saying they are of limited value and that there was scope for regulating the rating agencies.

"A rating gives a debt issue credibility", says DFCC Treasurer Dr. Harsha de Silva. "When a prospective investor has something concrete to rely on, he will not be swayed by rumours in the market place."

Though a committee was set up under the aegis of the Central Bank sometime ago to explore the possibility of setting up a rating agency in Sri Lanka, nothing has been heard of its activities in recent times.

"If a rating agency is set up today, it may not be taken seriously by investors", Dr. de Silva says. "It takes time to build up credibility, of the ratings given. Investors will watch the issues and assess whether they behave according to the ratings", he said.

Though ratings are at least in theory supposed to reduce the cost of funding, in some cases then may increase it.

Ratings are not always respected in the market place at least in Asia. Asiamoney cites the case of China International Trust and Investment Company (CITIC) which was downgraded by Moody's when its Hong Kong listed division CITIC Pacific was negotiating a US $ 258mn bank loan. The banks ignored the rating and total financing exceeded the target by 20 per cent. In another instance, Asia Pulp and Paper International Finance of Indonesia had managed to raise funds 25 basis points cheaper than a subsidiary given a higher rating.

Another contentious issue relates to the traditional practice of not rating any issue higher than the country risk rating or sovereign rating. Philippines San Miguel Corp, Asiamoney says raised US 115mn via a bond issue without a rating at a price of 190 basis points above the risk free rate. A rated sovereign (government) issue on the other hand had been priced 320 basis points above treasuries.

The rating practices of Western rating agencies had also come under fire from Malaysian Deputy Prime Minister and Finance Minister Anwar Ibrahim. He had branded the rating agencies' habit of giving lower rating to Asian countries with low debt, and giving higher ratings to developed countries despite their higher debt ratios, as 'completely irrational'.

Aussie firm ready for Rs. 300m power project

An Australian company is standing by to invest over Rs. 350mn in local hydro-power project, once a crucial agreement to sell power to the CEB is finalised, an official said.

Broadlands Energy Ltd., project promoted by Vanik Incorporation has tied up with Energy Development Ltd., Vanik Chief Justin Meegoda said.

The project is estimated to cost US $ 77mn or around Rs. 4bn. The hydro-power station will give a much needed 40 Megawatt boost to the country's generating capacity once it is operational. The hydro-power station will be commissioned on Build-operate-Own (BOO) basis.

Almost 70 per cent of the project cost is to be met from borrowings. The bulk of the financing will come from multilateral lending agencies, Vanik's Head of Corporate Finance, Bhatiya Amarkoon said.

A mini hydro power project was commissioned only last month by a private sector developer, making it the first to be operational since the CEB announced its intention of buying power from the private sector to keep up with the burgeoning demand.

Vanik is in the process of negotiating the power purchase agreement (PPA) which would enable the project to get off the ground, Mr. Amarakoon said Malaysia, Pakistan and India had already signed such agreements and Sri Lanka therefore had tried and tested models to go by, even though a lot of details had to be worked out.

Thought it is the intention of the promoters to ultimately seek a listing the power project will initially be less dependent on equity. Mr. Amarakoon said it may be more appropriate top seek a quotation once the projects was operational and generating returns, instead of making investors wait for several years, following investment.

Balanced monetary policy to fight inflation

Central Bank annual report shows shift in stance

By Asantha Sirimanne

Inflation should be brought down gradually over a period of time the Central Bank said in what is seen as a shift in its earlier stance.

"Reducing inflation to very low levels may not be feasible or desirable as such an attempt could perhaps drive the economy into a recession", the Central Bank said, in its 1995 annual report.

"A gradual reduction in the inflation should therefore be targeted and should be accompanied by a correction of the structural imbalances", it said.

The report said as in other countries, inflation was caused by changes in supply, structural rigidities and imported inflation. In addition there were also macro-economic imbalances such as a large fiscal deficit which contributed to inflation.

In 1995, inflation was 7.7 per cent compared to 8.4 per cent in 1994. The domestic economy had grown by 5.5 per cent down slightly from 5.6 year before.

Late last year, the Central Bank relaxed its earlier tight monetary policies in the wake of extremely tight liquidity, and high interest rates.

"To ensure that productive economic activities were not unduly suppressed by liquidity tightness, the Central Bank relaxed its tight monetary policy somewhat by purchasing Treasury Bills and permitting limited foreign borrowing by financial institutions", the report said. In addition the Central Bank had purchased Treasury Bills in the secondary market, retired its own securities on maturity and introduced reverse re-purchase facilities. But the Bank maintained a high reserve ratio of 15 per cent.

Narrow Money supply (M1) had grown by only 6.7 per cent in 1995, compared with 18.7 per cent in 1994.

However the Bank continued to warn against excessive growth in monetary aggregates. "If the money supply is permitted to increase beyond a certain level, given the limited existing production capacity, the consequences would be an increase in aggregate demand and a rise in the general price level," the Bank warned.

It added that imports fueled by domestic demand would affect reserves and exchange rates and lead to spiralling inflation.

The Bank also cautioned against borrowing from the Central Bank for financing deficits.

Commenting on other issues, the Bank said investors and employers had expressed misgivings about the proposed Workers' Charter influenced by the spate of industrial unrest.

"The government will have to be mindful of the need to create greater flexibility in the labour market, especially in the context of a large unemployed workforce", the report said. "A recognition by all parties of the need to link wage increases to productivity will have to be the basis of all wage negotiations in export industries, which face stiff competition".

The Bank also discouraged the use of import licensing in the import of certain agricultural products such as potatoes, big onions and chillies, which were costly to the consumer and undermined trade policy.

"Instead of licensing, a variable tariff system would be more appropriate to provide the required protection to farmers", the Bank said.

New look for CB Report

The Central Bank annual report has come out with a new look which not only enhances its presentation but also gives readers ready access to statistical information.

Graphics have been used liberally interspaced with the text and is a major improvement over the previous years.

Certain topics have been explained in box articles so that a reader with limited knowledge of economics may get a grasp of various issues.

Countries such as Malaysia use the box articles to give an in depth understanding of a specific topic such as the current account.

Usually the the focus will be on an issue that has particular relevance for the coming year.

The annual report is dedicated to the memory of the 41 officers of the bank who died in the bomb blast of January 31st 1996.

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