In the headlines recently was news that Fitch raised its’ outlook on Korea’s sovereign rating from Negative to Stable.
Fitch (not to be confused with the US clothing brand, Abercrombie & Fitch) Ratings is “a global rating agency committeed to providing the world’s credit markets with independent and prospective credit opinions, research, and data”, according to their website. Simply put, Fitch provides credit ratings on countries (called sovereign ratings), corporates, financial institutions, financial products, and more.
So far so good, but what’s a rating outlook? According to Fitch:
“Rating Outlooks indicate the direction a rating is likely to move over a one to two-year period. They reflect financial or other trends that have not yet reached the level that would trigger a rating action, but which may do so if such trends continue.”
Fitch currently has an A+ sovereign rating on Korea, so a Stable outlook would mean that the A+ rating is likely to remain that way for the next 1-2 years.
Now that we’ve learned what Fitch does and how their rating system works, let’s return to the main news story.
Fitch lowered Korea’s rating outlook from Stable to Negative in November last year on concerns that the financial crisis would widen Korea’s current account deficit and cause instability in the financial system.
Nine months have passed, and Korea has recorded a current account surplus for the last six months, while Korea’s financial markets – the stock market as well as the currency market – have stabilized.
So let’s take a look at what good things Fitch has to say about Korea in their recent announcement.
– Earlier pressure on the sovereign’s external balance sheet posed by domestic banks’ foreign-currency (FC) funding distress during the global credit crunch in Q408 have eased significantly since Q209.
– The term structure of banks’ external debt has improved, while banks’ repayment of FX liquidity support coupled with FC inflows in both the current and capital accounts have aided a recovery in foreign-exchange reserves in 2009 and helped improve Korea’s external finance indicators.
– On the public-finances front, Korea is likely to have avoided larges fiscal costs associated with the deleveraging of the banking sector, thanks to easing bank wholesale funding conditions and a quick export-led recovery from a sharp Q408 economic contraction, which resulted in only a mild deterioration in bank asset quality.
– Fitch anticipates Korea’s economic resiliency and the authorities’ (that’s us) upcoming efforts to re-establish a conservative fiscal agenda will likely provide scope for the government to revert to a fiscal balance position by 2011, with Korea being only one of six amongst all Fitch-rated sovereigns to do so from a deficit position.
So why is this upgrade by Fitch important (ie. why are we taking the time to write about it here)?
First of all, an upward revision of any kind simply feels good. If you paid for economy class but suddenly find out you’ve been upped to business, that’s good. If you order a cheeseburger but they upgrade it to a Big Mac, that’s also good (unless, of course, you don’t eat Big Macs). If they promote you from Vice President to President, that’s really good. You get the picture.
Second (and on a more serious note), Fitch’s outlook revision is significant because Korea is the only country (aside from a country in South America) that had its outlook raised. The rest of the world’s ratings or outlooks were downgraded.
Third, in a sense, the revision is a nice pat on the back for all the hard work that the Korean government has done in its battle against the financial crisis.
Fourth, a higher sovereign rating outlook means that the upgrades of Korean financial institutions are likley to follow. This was actually the case when Fitch, a day after announcing the sovereign outlook change, released another report saying that they are revising the outlook on Korean policy banks to Stable from Negative.
Fifth, a better outlook is expected to make it easier for financial institutions and corporates in Korea to raise capital in foreign markets. It also boosts investor sentiment, which is positive for stock and bond markets.
We are still in the middle of a global financial crisis, so we don’t want to be celebrating too early, but it does seem like Korea’s financial policy measures have worked so far. So how about a big round of applause for Korea?