THE well-known New York Times columnist Thomas Friedman once remarked that there are ‘two superpowers in the world today. There’s the United States and there’s Moody’s bond rating service.

The US can destroy you by dropping bombs, and Moody’s can destroy you by downgrading your bonds. And believe me, it’s not clear sometimes who’s more powerful.”

Although it is clear that the US remains more powerful, its clout was given a serious jolt on August 7, 2011 by Moody’s rival Standard & Poor’s when for the first time in history, it downgraded the United States by a notch, from triple A to double A plus.

But the US rejected the agency’s estimate saying it contained a $2 trillion error. There was little effect on the US economy.

On July 13, Moody’s caused a big surprise by downgrading Pakistan’s sovereign rating to its lowest level ever or to junk status for reasons of weak fiscal profile. But before its impact could be assessed, a week later Standard and Poor’s declared a ‘stable’ outlook for Pakistan’s economy. Which agency is more accurate is difficult to ascertain. In fact, their impartiality and fairness became seriously doubtful in recent years particularly during the sub-prime mortgage crisis. And despite warnings by the International Monetary Fund they have not been able to remove the ‘cloud of suspicion’.

Moody’s also cut the foreign and local currency bond ratings one step to Caa1 from B3 which happens to be their lowest assessment in more than a decade, pushing Pakistan to the level Cuba and Nicaragua are placed in. But, the analysts say, the downgrading of the country’s sovereign credit rating is unlikely to cause any crisis, or have any serious short-term impact on the economy. The decision has come at a time when Islamabad has begun mending its relations with Washington, a development that may improve the country’s macroeconomic stability.

What surprised Indian media was S&P’s positive rating for Pakistan for a few months back while it had downgraded its outlook on India to ‘negative’, largely on account of a large fiscal deficit and the lack of economic reforms.

And last month, it warned that India may become the first among the BRIC—Brazil, Russia, India and China—countries to lose its investment grade rating because of slow GDP growth and ‘political roadblocks to economic policymaking’ as some of the factors that could lead to such an action.

Moody’s has listed four major reasons for Pakistan’s downgrade: ‘a deterioration in the balance of payments over the past year, the looming large repayments to the IMF, the dwindling level of official foreign-exchange reserves, and the institutional weakness stemming from political instability and constrained government finances.” The agency also issued a negative outlook for Pakistan, meaning an upgrade is unlikely in the medium-term.

The last time Moody’s downgraded Pakistan to such a low level was on October 23, 1998, soon after the nuclear tests. It had immediately brought down Pakistan from B2 to B3 on the very day tests took place. Pakistan’s ratings stayed at Caa1 until February 13, 2002, but went up again to B3 for political reasons after Pakistan agreed to join the US-led coalition in the ‘war against terror’ and began receiving large amounts of financial assistance from Washington.

Moody’s highest rating ever for Pakistan was B1, which lasted from November 2006 to May 2008. The country was downgraded to B3 in October 2008, shortly before the IMF rescue package for Pakistan came into effect. On Nov 1, 2011, Standard & Poor’s has rated Pakistan as B negative, citing the country’s low-income economy, high public and external debt.

On July 19, Moody’s Investors Services downgraded the local-currency deposit ratings of five Pakistani banks by one notch from B2 to B3. They are Allied Bank, Habib Bank, MCB Bank, National Bank of Pakistan and the United Bank. Moody’s has lowered their stand alone credit assessments to Caa1 from B3 also. These banks, it says, hold “sizable direct and indirect exposure to the Pakistani government, which links the strength of their balance sheets closely to that of Pakistan’s, whose downgrade to Caa1 implies a greater probability of default over the short-term”.

According to Moody’s estimates, based on figures published by the State Bank of Pakistan, the banking system’s exposure to government bonds continued to increase in absolute amounts during the first quarter of the current year. This reflects the government’s increasing reliance on the domestic banking system to fund it deficits.

There will be no significant effect of the downgrade on the economy because Pakistan does most of its borrowing from the IMF and not from international capital markets. Mostly, the effect is likely to be psychological. For instance, foreign investors will now be more cautious while entering Pakistan. According to analysts, what Moody’s has essentially done is not to hurt the country’s future prospects but to admonish the economic managers for their past economic performance.

Moody’s has meantime downgraded 15 global banks, saying their capital-markets businesses suffered from volatility and the potential for ‘outsized losses,’ according to a statement.

The ratings on Bank of America and Citigroup were cut to two levels above junk. The rating company, based in New York, also downgraded 16 Spanish banks on May 17. The latest cuts reflect the government’s reduced creditworthiness, which lessens its ability to support the lenders.

The credit agencies have never been far from controversy. They do not appear accurate and credible.

They were, in fact, oblivious to East Asia’s financial crisis in the mid-1990s. In 2001, they gave Enron a clean bill of health until the collapse of the company. More recently, they came under fire in the wake of large losses, beginning in 2007, in the collateralised debt obligation (CDO) market, despite products being assigned top ratings.

But the irony is that despite the questionable role played by them in the past on several occasions, they still enjoy respect and clout in the market.

And the IMF, in a report, also does not strongly criticise the agencies, suggesting they play an important role in international markets. The financial crisis, it noted, has exposed ‘some flaws in the system’, including an over-reliance on ratings but these flaws could be rectified.