There is more to sovereign credit rating than meets the eye, as it is both an art through the assessment of subjective elements, and a science in the evaluation of data. Governments around the world, as well as major international corporations that issue securities, anxiously await learning of their latest rating scores. They are all nervous to learn whether they have been reaffirmed, downgraded or upgraded, with far-reaching implications on a country’s ability to raise funds at more competitive or premium rates. Unlike students who await to see if they obtained an A or C grade and an opportunity to discuss these with their professors for an adjustment, countries do not have this luxury. After a rating announcement has been made, it is certain. But they can still affect a final rating before it is announced by implementing policy measures to influence the outcome. The key issue facing governments is which of the two elements — the art or the science — can be positively presented as justifications for a rating upgrade. The science is easier. It involves assessing the level of national reserves, domestic inflation, taxation, balance of payments, import coverage ratios, subsidies, non-oil income generation measures, fiscal consolidation, net external debt and GDP, and exchange rate management. These can, and are, influenced by government policy decisions depending on the economic, political and social priorities of the day. The art element is more problematic, and while their overall weight in the final rating is lower than the scientific assessments, the more subjective element can also sway a final sovereign rating. These elements are grouped under environment, social and governance (ESG) matrices by providing scores against certain benchmarks using multiple regression models on a three-year centered average. Key analytical pillars include rule of law and governance risks, where the input variable is the World Bank indicators of rule of law and control of corruption. This sovereign rating ESG methodology is used by academic researchers. In the report “Political, Economic and Financial Country Risk: Analysis of the Gulf Cooperation Council,” both quantitative and qualitative factors are assessed, especially concerning the issue of law and order. The credit rating industry is dominated by three big agencies who control nearly 95 percent of the global rating business. Dr. Mohamed Ramady All countries, irrespective of their political and social structure, have passed laws, but assigning a rating weight for law and order is meaningless if it does not take into account the citizen’s willingness to abide by the law, and for the state to implement it without favor. This in turn influences the level of corruption and whether rating agencies can effectively measure national anti-corruption initiatives. In Saudi Arabia, there is a perceptible feeling among the business community that the level of corruption and bribery in connection with project awards has significantly diminished due to the zealous efforts of the Nazaha anti-corruption body. Is this accurately captured by rating agencies such as Fitch, which recently revised its outlook on Saudi Arabia’s long-term foreign currency issuer default rating to “stable” from “negative”? The credit rating industry is dominated by three big agencies who control nearly 95 percent of the global rating business, and these include Moody’s Investor Services, Standard & Poor’s, and Fitch Group, with the first two dominating 80 percent of the international market. All credit rating agencies are susceptible to major global events and criticism of favoritism in their rating reviews. Following the 2008 global financial crisis, many credit agencies drew criticism for being too relaxed and giving high credit ratings to debts that were high-risk, especially in mortgage-backed securities. Conflicts of interest were also levied against rating agencies due to their closeness to issuers of securities who pay the rating agencies for providing the rating services. Intuitively, rating agencies may be reluctant to give very low ratings to securities issued by companies or governments who pay their salaries. In summary, are there benefits in using the ratings of these agencies? Despite the grey subjective analytical areas highlighted above, yes, there are many. At the consumer level, the ratings are used by banks to determine the risk premium to be charged on loans and bonds, with higher or lower ratings determining the level of interest rates. At the corporate level, investors rely on the ratings of corporate securities issuance on whether to buy securities, while on the country level international investors are guided by positive or negative credit ratings. Can negative credit ratings be ignored? Theoretically yes — by the governments concerned — but it will come at a cost, as evidenced by the downgrading of the Greek, Portuguese and Irish country bonds in 2010 following the 2008 global financial crisis which worsened the overall European sovereign debt crisis. Another benefit is that credit ratings also aid the development of local financial markets by providing risk measures for various entities and deepening local capital markets, which happened in Saudi Arabia. Love them or hate them, until alternative independent risk assessment solutions emerge, rating agencies are here to stay as there is a significant response of government rating bond yield spreads to changes in both the credit rating notations and in the rating outlook, with response results more important in the case of negative announcements. For Saudi Arabia, upgrading from a “negative” to a “stable” outlook should incentivize the Kingdom to do better. • Dr. Mohamed Ramady is a former senior banker and Professor of Finance and Economics, King Fahd University of Petroleum and Minerals, Dhahran. Disclaimer: Views expressed by writers in this section are their own and do not necessarily reflect Arab News" point-of-view