THE COST OF BEING TRIPLE - A / THE WALL STREET JOURNAL

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SEPTEMBER 9, 2009, 12:00 P.M. ET.

The Cost of Being Triple-A

By RICHARD BARLEY


It ain't what you do, it's the way that you do it. Moody's latest thinking on triple-A sovereign ratings underlines that the key to a country's creditworthiness is the cost, not the quantity, of its debt.

The bond markets so far have played ball, providing stunningly large amounts of debt at very low rates to governments seeking to rescue their financial systems. Even so, U.S. and U.K. interest costs are likely to flash danger signals in coming years, emphasizing the importance of fiscal credibility if they want to stay triple-A.

For Moody's, the key metric is interest payments as a percentage of revenue, and the danger point is 10%, a level at which it believes debt becomes a serious constraint on government spending policies. The U.S. and U.K. are forecast by the agency to hit this level in 2012 – although that doesn't mean a downgrade is inevitable. There is a buffer zone that depends on how credible it is that the rise can be reversed, with the U.S. having greater flexibility and the U.K. somewhat less. That puts the onus back onto government actions – as economic growth alone is unlikely to do enough to repair the damage.

Quantitative easing has so far helped obscure the need for fiscal tightening. Central banks have been buying up government debt, helping to keep interest costs low in the U.S. and U.K. But quantitative easing doesn't reduce the size of the debt or increase government revenues, both of which are moving in the wrong direction. At some point, central banks must withdraw quantitative easing or risk damaging their own credibility, which would raise inflation expectations and lead to higher interest rates. If governments do not have credible fiscal tightening policies in place at this point, the bond market could react violently.

This transition seems already to be under way in the U.K., where both Chancellor Alistair Darling and Conservative leader David Cameron have made speeches this week on approaches to reigning in government spending. Managing market expectations will be another route to keep interest costs down – further helping to preserve triple-A status. But the point will come where actions, rather than words, are necessary.

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