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The economic role of governments in many countries is undergoing considerable transformation. Increasingly, governments are relying on market mechanisms to address the inefficiencies of the public sector. Even where privatization is not currently on the political agenda, policymakers worldwide are showing a growing tendency to expose remaining government-supported entities to market discipline.
In recent years, Standard & Poor's has adjusted its methodology for rating government-supported entities to reflect these trends. Whereas twenty years ago, ratings of such institutions were most often equalized with the ratings of their owner-governments, Standard & Poor's analytical approach has shifted toward an increasing focus on the stand-alone credit quality of the entity, and on determining the durability of the entity's links with the government. This approach is aimed at ensuring that government support is measured consistently and, where there is evidence that support is being reduced, that greater weight is given to stand-alone credit factors when determining the appropriate issuer rating. Abrupt changes in ratings thereby are minimized.
Standard & Poor's is now further refining its analytical approach toward rating government-supported issuers to more rigorously determine the extent to which the rating on such public sector entities is linked–if at all–to that on the government. This revised analytical approach reflects:
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Evidence in a growing number of countries of a reduction in government commitment and support for public sector enterprises. The privatization of enterprises, including entities once thought to be a permanent part of the public sector, is now relatively commonplace. Occasional defaults of public sector enterprises have been allowed to occur, and governments' official statements of support for public sector enterprises have become weaker or less clear-cut.
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The widespread sale of state enterprises, and policy developments such as competition policy in the EU, which not only are encouraging privatization but, equally important, are discouraging the use of government guarantees and other forms of ongoing state support.
Standard & Poor's analysis of the extent of government support for a public sector enterprise, if any, begins by classifying the entity on a continuum that currently encompasses three categories. The first and smallest category consists of public sector entities that Standard & Poor's considers to be most closely integrated into the government and its finances. The second category includes entities that are less closely tied to the government, but have a public policy role in which the government defines their performance and prospects. The last and largest category includes those entities that benefit from supportive government policies and possibly direct assistance, but that, whether currently regarded as such by the government or not, are most capable of functioning independently from it. This classification, in turn, has a bearing on the degree of rating enhancement for issuer ratings based on government support.
Stand-Alone Ratings |
Irrespective of the three categories under which the government-supported issuer is classified, the first analytical step is a determination of the entity's stand-alone rating. This is critical as it identifies the downside, or credit cliff, should extraordinary government support not be forthcoming in times of crisis. It provides important information about the asset quality of the owner-government, which may be relevant to the entity's own credit profile.
The stand-alone rating thus reflects the public entity's various strategies, performance, and prospects that are evaluated in accordance with criteria that Standard & Poor's has established for that specific type of entity. The analytical process includes comparisons with the entity's competitors, both locally and internationally.
Also, and particularly where privatization or reduced government involvement is on the agenda, Standard & Poor's makes assumptions as to what changes to the entity's capital structure and business focus are likely to take place on the way to privatization. This results in a stand-alone rating that is forward-looking and necessarily subjective, but that is nonetheless useful in managing the issuer's rating transition up to a possible eventual privatization.
For many government-supported entities, however, the determination of a stand-alone rating is not so clear-cut because of the intricacy of the government's involvement in many aspects of the entity's operations. This can include access to preferential funding, a monopoly position, favorable contracts, and sympathetic regulatory regimes, all of which are difficult-to-isolate forms of support that enhance both operational and financial performance. Conversely, price ceilings, risky investment project mandates, and directives to provide loss-generating goods and services represent forms of government intervention that constrains operational and financial performance. In these cases, assuming a sudden and complete stripping away of all forms of government influence may be neither practical nor informative. As such, the one assumption made in determining the stand-alone rating is that the government will not specifically intervene to maintain the solvency or liquidity of the public entity, or in other words that the government will not bail out the enterprise in a crisis. In short, Standard & Poor's applies the criteria for the type of entity being rated on the basis of that entity's existing business profile and financial position, including whatever government support or intervention the entity typically enjoys in the normal course of business, but excluding credit for any extraordinary government assistance that might be expected in the event of a crisis.
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Enhancement For Government-Support |
Following the determination of the stand-alone rating, consideration is given to government ownership and support.
Three Broad Categories of Government-Supported Entities. |
In assessing the credit implications of government ownership or relationship, Standard & Poor's generally classifies government-supported entities in one of three broad categories:
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High integration with the government. This is the smallest and a shrinking category of public-supported entities.
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Policy-based institutions, whose credit standing is linked to that of the government; and
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Other enterprises, where the relationship with the government is supportive and often enhances the entity's underlying credit strengths through helpful policies and the possibility of direct assistance. This category includes the majority of rated and unrated government-supported entities.
The purpose of this categorization is to clarify Standard & Poor's thinking about the relationship between the government and the entity concerned. It recognizes that there are a variety of relationships that imply varying degrees of government help, and varying degrees of certainty regarding government intervention. Standard & Poor's task is to evaluate the appropriate type of government support and factor it into the ratings in a coherent and consistent manner.
The strongest form of government support implies equalization of the ratings between the public enterprise and its owner-government. For policy-based institutions, depending on conclusions about the government's willingness and ability to provide support, the rating would, in general, be within two rating categories of the government's. For other public enterprises benefiting from a "supportive" government, the issuer rating would generally be no more than one rating category above its stand-alone rating.
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Defining the Three Categories |
In classifying the relationship between the government and the government-supported entity, the guidelines and reasoning outlined below are applied:
High Integration. |
The rating on the public enterprise is generally equated with that on the owner-government when the entity is a government department, ministry, or an agency that is either the source of substantial budgetary revenue, has a constitutionally or legally mandated place in the machinery of government that is difficult to change, or engages in activities that cannot readily be undertaken on a commercial basis. Government support does not result solely from the entity's policy role or importance, but rather from its place in the processes of government. Trends in the treatment of similar entities in other countries that enjoy a similar privileged status are relevant. The debt of these entities may or may not receive explicit guarantees from the government.
Changes in government policy could mean that entities in this category will migrate to other categories over time. Examples of entities currently falling into this category include:
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