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Tuesday,
May 19, 2020 / 5:40 PM / By Fitch Ratings / Header Image
Credit: Investing
Rapid increases in central bank purchases of
government debt provide short-term support for sovereign ratings by reducing
interest service burdens and rollover risks, but do not lower government debt
stocks or improve most other sovereign credit fundamentals, Fitch Ratings says
in a new report. With credit market pricing under considerable central bank
influence, we believe it is incorrect to equate the resulting effective
ceilings on sovereign bond yields with floors on sovereign credit ratings.
In a special report focused on investors' questions
related to central bank bond purchases, Fitch indicated that, while such
purchases are neither new nor unique to the quantitative easing (QE) era, they
are much larger and have been undertaken more quickly in response to the
coronavirus pandemic, and are therefore accompanied by more meaningful
macroeconomic risks and consequences.
There are few technical constraints on central bank
balance-sheet expansion in a 'fiat' money system, but this unique feature
ultimately stems from the private sector's trust in the currency as a store of
value and means of settlement and exchange. Sustained reliance on central banks
to support fiscal policy goals would risk undermining their independence to
pursue monetary policy objectives and could boost long-run inflation
expectations. Were such financial repression policies to become entrenched,
they could have adverse consequences for economic performance over the long
term - including distortions to risk pricing and the allocation of capital and
an over-reliance on debt - and important distributional effects.
From a sovereign rating perspective, one of the most
obvious consequences of the pandemic is an increase in government deficits and
debts, as policymakers seek to counter the economic fallout. But as debt
issuance has gone up, funding costs have generally come down, at least for
sovereigns issuing into domestic markets, and especially for those whose
central banks are engaged in QE. These more favourable funding conditions are unambiguously
positive for sovereign ratings.
However, a government's cost of funds is only one
rating consideration, with the overall sovereign credit profile being
determined by the sustainability of the government debt stock, several
structural factors, macroeconomic policies and prospects, as well as a
country's external financial position. To the extent that lower interest rates
prolong a period of higher government debt, as seems to have been the case for
some sovereigns over the past decade, short-term rating gains can be offset
over time.
In Fitch's view, macroeconomic policy coordination
between the central bank and government is critical in times of crisis. But
since the central bank balance sheet is ultimately underwritten by the
government, financial support flowing in the opposite direction cannot be
unlimited. From a debt perspective, the agency considers the central bank to be
a creditor of government, not part of government.
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