A New York Firm That Shakes Economies

The way Vincent Truglia describes his work it's the perfect academic atmosphere. He and his colleagues debate arcane financial principles with Socrates-like reasoning. They crunch numbers to validate their theories. They issue grades.

But from their offices in a nondescript concrete building in Manhattan, he and his colleagues increasingly shape the financial fate of nations. When Moody's Investor Services issues a credit rating, prime ministers call press conferences, currency traders hit the phones, and bond markets quake.

And their ratings are causing more debates - chiefly from those who have just seen their country's economic prospects reduced to a few letters.

In an increasingly interdependent global economy, all the noise over how Moody's and a handful of other private companies rate a country's debt is creating an international stir that highlights the cultural differences between East and West. A case in point is the Asian crisis. While Western investors want "transparency," details on how a country's economy is working,

those in the East say what matters is that it works while maintaining traditional values.

On July 22, Moody's said it was placing Japan's AAA rating under review for a possible downgrade. This prompted Finance Minister Hikaru Matsunaga to complain that he couldn't understand Moody's action. "Japan's economic fundamentals are firm, and this is merely a temporary downturn."

Those ratings, from the AAA US government bonds to the lowly noninvestment grade E, have become increasingly important as foreign countries and their institutions tap the international credit markets for money. Investors want to know whether they are going to get their money back or have to deal with a default, which happened to the debt of nine countries between 1970 and 1990.

"The third-party judgmental role is a very important duty - people are very unhappy when they get surprised," says David Rolley, the emerging-market debt strategist at Boston-based Loomis-Sayles & Co.

For some countries, the credit ratings have become a matter of national pride. After Moody's downgraded Italy in 1993, the country's president accused Moody's of being part of an international conspiracy to destabilize the country.

Ratings, not report cards

Although the rating organizations try to discourage countries from thinking of the assessments as "report cards," many countries do anyway.

"It's not a general report on the whole economic future of the country, it is specifically focused on the risk for creditors," says Christopher Huhne, the London-based group managing director of sovereign ratings for Fitch IBCA, a French-owned rating agency. But, he adds, "A lot of policy makers tend to think if they have a good rating that tends to reflect well on their policies as well."

The ratings do matter, and differences can cost a country a lot of money. For example, last July the Republic of Korea (then rated AA-) borrowed $2 billion. In April, it issued more debt, but its credit rating had sunk. So it cost the country $83 million more in interest expenses.

That didn't stop buyers of the debt - the Korean offering was actually increased in size to reflect a lot of demand. "A lot of people felt they were locking in a spread [the increased borrowing cost] that would improve over time," says Joyce Chang, manager of emerging markets research for Merrill Lynch & Co.

The ratings downgrades may mean many investors don't participate, however. "Everyone is guideline constrained," says Mr. Rolley. "We use them, everyone uses them."

The rating agencies' actions has resulted in a raging debate, particularly in Asia where some view the credit-rating companies as "arrogant." That's the view of Tsuneo Iida, a professor of economics at Japan's Chubu University, who adds, "The activity to rate something with numbers is such an American thing." He cautions, "But, they should remember that numbers don't always represent everything."

On July 27, after Moody's downgraded the debt of Malaysia, the country was forced to postpone a $2 billion bond issue. The delay raises doubts about a recovery plan needed to prop up banks and revive the nation's economy. One newspaper reported that an official called the action "grossly unfair."

Sometimes, the language is a lot less diplomatic. Last February, after Moody's downgraded Thailand's debt, the country's deputy prime minister said, "Since they are trying to destroy us, why can't we try to destroy them."

'We are not detectives'

The downgrades came after rating agencies became particularly upset with some governmental miscues. Thailand, intent on defending its currency, purchased foreign-currency futures with its reserves. When its economy soured, those contracts lost billions. Korea invested its reserves in the foreign branches of its banks. That meant those reserves could no longer be used when the country tried to defend its currency.

The rating agencies were not informed about these changes. At Moody's, two analysts - both Westerners - read about rumors in the Korean newspapers. Moody's went to the government, which at first denied the reports. "If a government wishes to hide something, as in these countries, we are not detectives," says Truglia, a managing director.

Instead, he says Moody's gets most of its information from conventional sources - such as the World Bank and International Monetary Fund in Washington and the governments themselves. In addition, Moody's offers to meet with any of the 105 countries it rates to listen to the finance ministries. "We may certainly have information that may not be published in other forms, but we don't want secret information. We want information to be given to everyone," says Truglia.

But many investors count on rating agencies to sort through the chaff. Jeff Davis, chief investment strategist at State Street Global Advisers, which manages $450 billion in assets, says he looks at ratings as a way to determine how well a country is handling its finances. "I treat it as an evaluation."

When that evaluation changes, he says, "it's an important signal - it may mean there are changes in the macroeconomic picture." For example, he finds the latest warning on Japan disturbing. "It means something is deeply wrong."

Like the countries, not all investors are happy. Bernard Horn Jr., president of Polaris Capital Management, complains that the rating agencies are sometimes late in their assessments. "Most people's expectations of these credit rating services is that they should be more of a predictive mode versus trying to react to financial stress and crisis," says the Boston-based global equity manager.

The rating services are more than aware of the criticism. In January, Fitch IBCA ratings group wrote a post-mortem of the Asia turmoil, in which it admitted it made mistakes. In the future, says Mr. Huhne, the credit-rating agency will look more closely at a country's "weak links," such as the banking industry, which might make the country vulnerable.

Moody's also reviewed its actions in a "white paper," which looked at its competitor's actions and the criticism from bond issuers and finance ministers.

Truglia says Moody's has learned not to assume that governments will follow "reasonable" actions. "What we have concluded is that we are going to have to be even more skeptical about levels of international reserves," says Truglia.

Growing skepticism

That skepticism is likely to surface in the periodic research the agency produces. He readily admits that some countries are harder to read than others. In China, for example, he says, "If anyone tells you that they understand what's going on inside the State Council, I think they are deluding themselves."

Moody's uses one lead analyst and a backup per country. However, a committee makes the rating decisions. To be fair, the majority has to come from outside the region to avoid regional bias and to make sure there is a vibrant debate.

Most of Moody's sovereign-debt analysts have experience at an international lending institution such as the IMF. The analysts prefer to remain anonymous - simply observers. But this has not stopped the media from trailing them into elevators. Truglia says the most commonly asked question is: "Why do you hate our country?"

A Canadian newspaper once wrote a two-page story speculating on what Truglia looks like. "So ... when people meet me, they look at the color of my eyes and say, 'We finally have the answer,' " he chuckles. In the interest of transparency, they are brown.

* Nicole Gaouette in Tokyo contributed to this report.