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13 May 2013
New research by Cardiff Business School’s Dr Vito Polito and Professor Michael Wickens has cast doubt on the timing of the recent downgrades of the UK.
Using modern tools of economic analysis, the research provides a model-based measure of the sovereign credit rating that gives findings somewhat in contrast to the ratings given by Credit Rating Agencies (CRAs).
In the first four months of 2013, two of the major CRAs have downgraded the UK economy (Moody’s in February and Fitch in April). Dr Polito explains: "Our analysis suggests that the UK should have instead been downgraded much earlier, in the aftermath of the run on Northern Rock (September 2007)."
The model downgrades the UK during the early phase of the financial crisis, which coincides with the unprecedented deterioration of the UK public finances. Dr Polito adds: "Between 2008 and 2010, only Greece, Iceland and Ireland have accumulated deficits as a proportion to GDP higher than the UK. The UK debt-GDP ratio almost doubled over the same period of time. From the point of view of our model, it is inevitable that this sharp deterioration of the UK fiscal stance leads to a downgrade."From the end of 2010 onwards, the credit rating obtained from the model begins to recover towards triple-A, though there is a large degree of uncertainty about its value by the end of 2012. This improvement in the credit rating is related to the gradual recovery of UK public finances over the past 3 years: the deficit as a proportion to GDP has been stable in 2010 and it has halved by 2012; consequently the pace of the increase in the debt-GDP ratio has also slowed significantly."
Dr Polito emphasises the importance of transparent and timely measurements of the credit rating: "Sovereign credit rating issued from CRAs are evaluations of the likelihood of default of a country. Since these evaluations are essentially analyst-driven, they lack transparency and are difficult to monitor and understand by the general public," he said.
The European Commission has recently argued that a general obligation for investors is to do their own assessment of the credit rating rather than over-relying on CRAs. One reason often advanced for the dependence on CRAs is the expense and complexity of providing a credit rating.
Dr Polito added: "Model-based credit ratings not only are timely and easy to interpret, but are also easy and relatively inexpensive to produce. Thus they can be used by individual investors and market analysts as benchmark measures of the sovereign credit rating to be compared against the ratings issued by CRAs."
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