A “C” rating from the US government credit evaluators, coming after Washington has held up the $10 billion loan guarantee for more than four months, must come as something of a shock for Israel. Only last September Jacob Frenkel, governor of the Bank of Israel, told the Financial Times that a “good borrower like Israel” needed the loan guarantees to “go to the marketplace with an implicit vote of confidence in the economy, its prospects, and in the economic strategy that it has.”
Israel may be a good borrower, judging by its no-default record, but so would any country that had 200 members of Congress periodically writing off old credits and guaranteeing annual positive net disbursements (passed by Congress in 1984 as Public Law 98-473). Governor Frenkel surely knows that this rating is not one Israel can “take to the marketplace” and find an enthusiastic reception. A “C” grade puts Israel in the company of Columbia, Czechoslovakia, Lesotho, Mexico, Tunisia, Turkey and Venezuela, as far as the credit risk evaluators of the Office of Management and Budget (OMB) are concerned. While these countries all enjoy market access, they would have an extremely difficult time borrowing $10 billion (let alone more, which is what Israel intends to do) in a short period; and if they could, the interest costs would be prohibitive. With the guarantee, Israel can borrow at rates roughly on a par with US Treasury Bonds. The significance of the credit rating is not only for these $10 billion but also for the country’s other borrowings.
Because the “C” rating does make guarantees and loans more costly to the US government, it does have a bearing on Israel’s future access to the market. The 200 congressmen are thus no more quite the asset they once were, since now the guarantees or loans they may approve have a risk of premium attached to them. Given the size of US outlays to Israel ($4 billion out of a total foreign aid budget of $14 billion), and the fact that the foreign aid budget has been “fixed,” the additional risk premiums “crowd out” aid and lending to other countries. At a time when East European countries and the former republics of the Soviet Union seem to have considerable aid requirements, let alone the growing domestic resentment toward “foreign aid,” it makes appropriating aid and guaranteeing loans to Israel more difficult.
Israel’s unflattering rating was not the result of underhanded bureaucratic maneuvers. Israel was far from the minds of analysts who promoted the Budget Reform Act of 1990, which instructed the OMB set up an inter-agency committee to assess the credit risk to the budget of domestic and foreign borrowers seeking funds from the US government and through US government guarantees. This reflected both the internal budgetary problems faced by the US government and the Third World debt crisis.
The budget reformers were seeking to “correct distortions of the budget” caused by the widespread practice of guaranteeing loans. Prior to the Budget Reform Act, loans and grants to foreign countries were fully appropriated — i.e., the entire amount was reflected in the budget. Guarantees, on the other hand, had no budget impact, unless the debtor country defaulted and the US had to pay off the obligations. In a tight budgetary environment, it became easier for legislators and aid officials to make loan guarantees than to appropriate money. It was these circumstances that prompted supporters of Israel to suggest the $10 billion loan guarantee.
The inter-agency committee — comprised of representatives of the departments of Treasury, State, Agriculture, the Export-Import Bank and the OMB — has a mandate to assess the actual risk of default on the loan, in the same manner as private-sector rating agencies. That is not to say that inter-agency politics do not enter into the committee’s work. The precise definitions that will help different agencies categorize countries when assigning ratings and risk premiums have not been pegged down. Treasury and State favor a more flexible rating system, so as not to hamper foreign policy objectives. But the OMB, the Export-Import Bank and Agriculture, looking from a narrower budgetary perspective, have pushed for more restrictive categories. They seem to have the upper hand mainly because the Export-Import Bank already has a working rating system, has more experience in evaluating country risk and has the support of the OMB.
In Israel’s case, Treasury wanted to rate it a “B,” but met stiff resistance from the OMB and the Export-Import Bank. Treasury then came up with “Country Risk Classification Guidelines by Factor,” which redefines the significance of the ”C” in Israel’s favor. This rating system classifies “C”-rated countries as World Bank middle-income countries with a positive outlook for economic growth, average inflationary expectations of less than 15 percent and no recent or expected payment arrears, but warns that “access to foreign exchange may be insufficient to avoid rescheduling without additional adjustment effort and/or added external assistance.” The secondary market price for a ”C” country’s commercial bank debt is greater than 70 percent on the dollar; Moody’s rates it at Baa and Standard and Poor assigns it a BBB rating. These countries get a generally clean political bill of health: “No major political or social constraints that could be expected to undermine further the country’s capacity or will to service its external obligations.” Treasury’s opponents in the committee are currently formulating an alternative set of guidelines to go to Congress for approval.
The Bush administration did not hold up Israel’s loan guarantees on budgetary grounds. But the new regulations under the Budget Reform Act, whereby a risk premium attached to a loan guarantee must be accounted for “above the line” in the budget, has provided Congressional critics of foreign assistance with a new tool for restricting aid. Supporters of Israel have suggested that Israel will pay the risk premium to lighten the load on the budget, but US government credit evaluators consider this a corruption of the system. A risk premium is a hedge against risk, they argue, and just because the debtor pays the premium does not lessen the risk of default. Congress can easily amend the OMB’s rating of Israel. So can the administration. Whether this happens depends on politics.