While police were clubbing down protesters in the streets of Karachi Monday, Moody's Investors Service announced that Pakistan's "credit rating" had been placed "under review."
We don't yet know how President Pervez Musharraf reacted to this dour expression of market disapproval. Earlier this summer, on the same day Musharraf ordered an assault on religious militants holed up in the Red Mosque, Standard & Poor's lowered its outlook for Pakistan's credit rating from "positive" to "stable," and in late September, the price of insurance against Pakistan defaulting on its own bonds shot up. But neither signal from international investors that they were unhappy with the direction of events in Pakistan appears to have made an impression on the military dictator.
So what does it mean when a country's "sovereign" credit rating gets downgraded? We've seen, as the subprime drama rolls along, that decisions by ratings agencies can have immense downstream effects. The Wall Street Journal reported on Monday how downgrades on tens of billions of dollars of subprime-linked securities issued by Moody's and S&P in October were directly responsible for the huge write-downs announced just weeks later by Citigroup and Merrill Lynch, and the consequent resignation of the CEOs of the two investment banks. So is it too much to hope that a downgrade of Pakistan's sovereign credit rating could lead to the downfall of Musharraf?
The immediate answer would appear to be no: As long as the United States continues to funnel billions of dollars of military aid to Pakistan, Musharraf has the leverage he needs, and so far, despite their glum expressions, U.S. officials are unwilling to cut off the tap. But in an ever-more globalized economy it may be worth asking whether anxious financial markets will become more influential in determining the direction of domestic politics, for good or ill.
Practically speaking, a credit rating downgrade usually means that it becomes harder for a company or a country to raise capital on financial markets. Studies have demonstrated a clear trickle-down effect from downgrades applied to sovereign credit ratings. For example, domestic firms in developing nations tend to have individual credit ratings that are closely linked to sovereign credit ratings. Consequently, such firms will also find it harder to raise capital. Research indicates that the mere announcement of a sovereign credit downgrade precipitates a measurable stock market decline in the affected country.
The flow of deal making that is the very stuff of globalization may also hit some bumps.
The perception of higher risk may also hurt any premium Pakistan could have demanded on deals such as a global depository receipt, worth at least $644 million, for shares in state-run National Bank of Pakistan, expected on sale next month. Other deals include the acquisition of a majority stake in Pakistan's Saudi Pak Bank by a consortium including Bank Muscat and Japan's Nomura Holdings, and a stake in Pakistani cable and telecom operator World Call by Oman Telecommunications.
We tend to hear a lot more about Taliban sympathizers in the Northwest Frontier province of Pakistan than we do about foreign purchases of chunks of Pakistani banks and telecommunications companies. But Musharraf's status quo could be under just as much threat from one sector as the other, if Pakistan's credit continues to deteriorate.
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