THE ROLE OF RATING AGENCIES IN FINANCIAL MARKETS 1.

The main propose of the project The objective of this article is the inquiry on the hypothesis that credit rating agencies have contributed to the emergence and deepening of the latest economic world crisis and also the impact of the rating given by the rating agencies for Romania and Lithuania during this period and the effect of their decisions. We tried to realize a comparison between these countries according to their country risk. The importance of this subject results from the rating big impact on the international financial market, and therefore, on the world economy. 2. The concept of country risk and the determinants of country risk A collection of risks associated with investing in a foreign country. These risks include political risk, exchange rate risk, economic risk, sovereign risk and transfer risk, which is the risk of capital being locked up or frozen by government action. Country risk varies from one country to the next. Some countries have high enough risk to discourage much foreign investment. There is an amount of country risk concepts highlighted in the literature, considering country risk is a set of sovereign actions, political decisions and also an economic or financial risk. The concept of country risk has a broader conception and shouldnt focus only in political risk. Moreover, due to financial deregulation or regulation according to some opinions, connections between states and economies have made political risk to join the economic, financial and even systemic risk. Other opinions, have multiplied the approaches of the concept of country risk, together with entities that deal with its analysis. Other studies developed new perspectives of country risk such as: The perspective of the economic actor type reached by risk (creditor): banks, investors (financial or industry risk), exporters (commercial risk); Nature of risk (specific entity receivable, generating the risk) - in this regard, John Calverley (1990) develop a sovereign risk and a non-transfer one; The type of crisis that leads to the manifestation of risk: evokes the sovereign and the political risk (with their clear differentiation), the economic risk and the financial risk.

At the same time, according to other approaches country risk is depending on the type of the state or on the nature of the reviewed agents and therefore there is a need for distinction between sovereign and country risk concepts. Generally, sovereign risks definitions given by the analysts, coincides with the maximum score of the state (sovereign ceiling), and local agent could not receive higher ratings than the countrys sovereign risk rates. Country risk analysis is a strategic tool in supporting decisions and reducing uncertainty. The bet for a country is to anticipate economical changes or incidents that may affect the development of transnational business - macroeconomic, financial or socio-political fragility of a state which are likely to choke financial or commercial operations. The remarks of such an analysis are addressed to banks, credit institutions, investors and exporters. Investors will be interested in
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industrial risk sizing, which involves the faulty running manufacture or sale processes and may extend to expropriation / confiscation, or financial risk sizing in terms of changes in the remuneration of securities, while lenders will be concerned with nonpayment risk or late repayment risk. Assuredly, risk assessment interests depends on the state, hence country risk, will be re-analyzed especially in the case of a relationship with an emerging one or some economic agents generating from it. The aspect that raised further discussion and greater concerns for the methods of country risk analysis, as stated by Meunier, N., Sollogoub, T., (2005), evokes two main tracks: The use of specific indicators and the establishment of a specific diagnosis; The use of empirical methods - the relationship of pre-selected set of variables.

The identification of a reliable and qualitative indicator, in order to anticipate difficulties is a major challenge for the analysts. This approach has gained considerable importance especially after the South American debt crisis in the '80s. This crisis brought out the difficulties of paying a debt in foreign currency. Generally a crisis emerged when a state have a higher average of the emerging market external debt. In the context of the main determinants of country risk, Meunier, N., Sollogoub, T., (2005) and Thalassinos et al., (2006, 2010a, 2010b) brings out three concepts, also used by most rating agencies, which set their own thresholds for alert: Solvency, the total debt versus the rich states; Sustainability, the evolution wealth debt to global developments guidance on the long field; Liquidity, the ability of debt repayment at maturity - short-term orientation;

Among other determinants of country risk, also mentioned: - External debt relative to gross domestic product. It should be noted that it is also important the currency which the debt is expressed. A major part of the debt being expressed in foreign currencies translating in additional risk if the currency is experiencing a depression; - External debt relative to export volume as it is expressed by the external debt relative to the ability to attract foreign currency. When the value of this indicator exceeds 150%, is an alert corresponding to an over indebtedness; from this perspective, it needs to be emphasized that a favorable development of exports improves prospects for external debt repayment; - External debt service to GDP and external debt service relative to the volume of exports. These indicators are used frequently by the World Bank to rank states according to the level of indebtedness; - Currency exchange reserves covering more than three months of imports; - Total external debt which is dangerous if it exceeds 50% of GDP; - Inflation rate which is dangerous if it exceeds the threshold of 10.5%; - Real interest rate;
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- Existence of agreements with the International Monetary Fund, essentially positive aspect, generating trust, but can hide the crisis element; - Political risk and psychological factors; - Economic structure of incomes; - Balance of payments flexibility. Balance of payments analysis presents particular importance in tracking the various disturbances in supply/demand, savings / investment, private saving / public saving. Also, it can be achieved the current deficit explanation and determined the status of the international creditor or debtor of the analyzed state. In regard of specialized companies, risk analysis should be provided and disseminated through press releases, publications or through the Internet. In his study Evaluation du Risque pays par les agences de rating: transparence et convergence des methods, Guessoum., Y., (2004) distinguished different types of institutions carried out country risk assessments: Rating agencies - most notable are Moody's, Standard & Poor's and Fitch, their activity will be explained briefly below; Insurance companies (e.g. COFACE - Compagnie Franaise d'Assurance pour le Commerce Extrieur); Consultancy offices (North South Exports to France, Business Environment Risk Intelligence); Financial publications (Institutional Investor, Euromoney Publications); Banks, etc.

3. What do Rating Agencies evaluate and the comparison between them The most important credit risk rating agencies are: Fitch , Moody's, Standard & Poor's (U.S), Business Monitor International, CTRISKS, whereas the most famous political risk analysis organizations are, among others: Business Monitor International, Country Risk Solutions, Economist Intelligence Unit, Eurasia Group, The Legion Group, The PRS Group, Inc. The rating agencies evaluate ranks states in terms of loans and bonds issued. Four major classes of risk are defined, for Standard & Poor's and Moody's, the descending order from the highest level of risk when the country's ability to repay both the debt and interest to the most unfortunate situation of non repayment is as it follows: S&P: AAA AA A BBB BB B CCC CC C D Moodys: Aaa Aa A Baa Ba B Caa Ca C D In two of the indicators are found the signs "+" and "-". They point perspectives, the possible development of note and are the first priorities for change. Among the factors used by agencies in conducting evaluations also included the balance of payments and the current account, the level of debt, the deficit level, the structure and the economic growth, the exchange rate and the convertibility of the local currency, the total GDP and the GDP per capita, the labor cost factor
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and the productivity, the total level of reserves, the interest rates, the inflation rate, the liquidity, the political environment, the international agreements, etc. The share of different criteria and evaluation methodology are unknown to the public. Also it is noted the possibility of classifying factors into two categories: quantitative factors (objective criteria) and qualitative factors (subjective criteria). Although there are major similarities between agencies, some of the used criteria vary from agency to agency. Standard & Poor's uses 9 clusters of criteria namely political risk, international relations, social environment, economic structure and growth prospects, flexible tax system, flexibility of balance of payments, external debt and liquidity, borrowing costs, price stability, while Moody's, uses 5 clusters namely political dynamic and social interaction, structure and economic performance, tax indicators, external payments and debt, monetary indicators and liquidity. In the contrary, Fitch uses 14 clusters of criteria namely policy and state, international position, demographic factors, employment, production and trade structure, dynamic private sector, supply / demand balance, balance of payments, macroeconomic policies, FDI policy , banking and finance, foreign currency assets, the external debt and the economic growth. Which one is the most reliable the most objective one is difficult to say. In addition the foremost problem is the transparency of the scoring process, as most of the institutions do not use the same evaluation process and a number of factors may cause differences between various evaluations such as the criteria taken into calculation, the methodology used and the type of grades awarded Each CRA has its own rating scale. Moodys and S&P use the two principal scales. Moodys highest rating is AAA, and anything between AAA and Baa3 is investment grade. S&P and Fitch share a scale, with AAA being the highest rating. Ratings between AAA and BBB are investment grade. Ratings below these levels are considered speculative, a label that denotes a risky investment. The less risk a CRA perceives in an entity or the issuing debtor, the higher the rating. Therefore, when comparing financial instruments promising the same yields, investors are more willing to invest in the higher-rated instrument. Certain institutional investors, such as pension funds, are only permitted by law to invest in investment grade instruments. A low rated entity must provide investors with additional incentives, such as higher interest rates, to convince them to invest. In this way, ratings directly affect the cost of raising capital. For example, in 2004, S&P data showed that if an entity advanced from a category BBB to a category BB, its borrowing costs were reduced by almost 50 percent. While each CRA has its own unique rating procedures, the general process is similar across most CRAs. A credit rating is based on both quantitative and qualitative values.

4. The role of RA in the financial crisis The Asian, Russian and Latin crisis, as well as the crisis that began in 2007, were not anticipated by the rating agencies. This brings into question the functionality of their existence, since numerous econometric analyses revealed serious deficiencies in the foundations of individual states credit ratings. The reason for this crucial deficiency of rating agencies most probably lies in the over-weighting of subjective factors when awarding credit rating. In addition, rating agencies are typically late with the lowering of ratings and they ignore numerous
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macroeconomic signals. The moment they decide to lower ratings, they act as an element of panic, instead of acting as an element of calming the market through the prediction of economic movements. The current financial crisis has prompted an examination of the role of credit-rating agencies (CRAs). With the rise of structured finance products, the agencies rapidly expanded their ratings business and earned dramatically higher profits (Moodys, for example, tripled its profits between 2002 and 2006). Yet ratings quality seems to have suffered, as the three main agencies increasingly gave top ratings to structured finance products shortly before the financial markets collapsed. Both the effective costs of providing high-quality ratings and the benefits to the CRA of doing so vary through the business cycle. Several economic fundamentals suggest that ratings quality is lower in booms and improves in recessions. An explanation for this affirmation relies in the fact that in a boom, it is more expensive to hire skilled analysts. The CRA can earn more in a boom, and so may be tempted to capitalize on the opportunity to earn the higher revenues available. The CRA could do so both directlythrough higher volume of issues and, perhaps, through higher feesand indirectlythrough advisory and other ancillary services. In addition, if issues are relatively unlikely to default in boom periods, monitoring a CRAs activities is less effective, and the CRAs returns from investing in ratings quality are likely to be diminished. Default probabilities may actually be higher towards the end of a boom if lower-quality issuers seek to be rated. Credit rating agencies (CRAs) bear some responsibility for the financial crisis that started in 2007 and remains ongoing. This is acknowledged by policymakers, market participants, and by the agencies themselves. It soon became clear that, given the depth of the crisis, CRAs would not be able to satisfy policymakers by eliminating flaws in their rating methods and improving corporate governance. Although the CRAs were more or less unregulated before the outbreak of the financial crisis, after the crisis started, politicians became increasingly vocal in demanding regulation. Initially, these demands were confined to a more binding form of self-regulation. But as the crisis progressed, the calls for state regulation grew ever louder. There is a broad consensus that credit rating agencies (CRAs) contributed to the current financial crisis, which began in the United States (US) in summer 2007 with problems in the subprime mortgage market and has since taken on global dimensions. The agencies underestimated the credit risk associated with structured credit products and failed to adjust their ratings quickly enough to deteriorating market conditions. CRAs were accused of both methodological errors and unresolved conflicts of interests, with the result that market participants confidence in the reliability of ratings were seriously shaken. It is unsurprising, against this backdrop, that a heated debate emerged about the rating process, rating agencies, competition, and liability rules, prompting calls by politicians for greater regulation of CRAs. Yet such calls are not solely a product of the present financial turmoil. They have featured on the agenda of international financial market policy since, if not before, CRAs came under fire in the wake of the series of debt crises starting in 1997. The growth of the international financial markets over the last twenty years would have been unthinkable without CRAs. Only because of the availability of clear, internationally accepted indicators of the risk of default were investors willing to invest in international securities
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whether corporate or government bondswhose credit quality they would have been virtually unable to assess on their own. The CRAs worked for decades on designing a simple and readily understandable system that would allow any investor to invest in international securities with which they were not directly familiar. Where corporate and government bonds are concerned, this system has proved reliable and enabled investors to diversify their portfolios. In the markets for structured products, by contrast, the role of the CRAs goes far beyond eliminating information asymmetry. Markets for structured products could not have developed without the quality assurance provided by CRAs to unsophisticated investors about inherently complex financial products. CRAs have operated as trusted gatekeepers. However, the ratings for structured credit turned out to be much less robust predictors of future developments than were the ratings for traditional single name securities. Over the past two years, changes in the ratings of structured credit have been far more volatile than the historical record for single name credits, and far more weighted toward downgrades. The resulting instability of ratings has not only had direct procyclical effects, but has undermined confidence in the future stability of credit ratings. Against this backdrop, calls for CRAs to be regulated in a new and more stable world financial order fell on fertile ground, all the more so given that the CRAs could be accused of making some serious errors. A number of official European reports have now described in detail how certain flaws in the rating process and the conditions governing the financial markets contributed to the crisis. The first comprehensive analysis appeared on 7 April 2008, when the Financial Stability Forum (FSF) published its report on enhancing market and institutional resilience (Financial Stability Forum 2008). This report concluded that the CRAs substantial underestimation of the risk inherent in structured finance products was partly due to methodological shortcomings. Singled out for criticism were the inadequate historical data, which significantly increased model risk, and the fact that CRAs had not taken sufficient account of deteriorating lending standards. The report took a positive view of the measures already introduced by the CRAs; nevertheless, a need was seen for further steps to improve internal governance, the transparency of rating procedures, and compliance with international codes of conduct. There was criticism, too, of CRAs failure to publish verifiable data about their rating performance. The agencies were urged to disclose this information in as standardized a form as possible. The report also called for a distinction to be made between ratings of structured finance products and other corporate bonds in order to highlight the differences in the methodologies used and the significantly different risk characteristics involved. The FSF felt, however, that more in-depth analysis was needed of the implications of such a step for the functioning of the market and the regulation of the industry. In addition, the FSF report criticized CRAs for failing to adequately monitor the quality of securitized products. More rigorous scrutiny of lending practices was therefore called for. And last but not least, investors and supervisors were called on to examine whether they may have placed too much confidence in ratings. Further reports by expert bodies and regulators were published over the course of the following twelve months. In February 2009, the committee of European Commition published a report that cited the following shortcomings (de Larosire Group 2009):
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CRAs lowered the perception of credit risk by giving AAA ratings to the senior tranches of structured finance products like collateralized debt obligations (CDOs), the same rating they gave to government and corporate bonds yielding systematically lower returns. Flaws in rating methodologies were the major reason for underestimating the credit default risks of instruments collateralized by subprime mortgages. The report was especially critical of the following factors, which were all felt to have contributed to the poor rating performances of structured products: - the lack of sufficient historical data relating to the US subprime market, - the underestimation of correlations in the defaults that would occur during a downturn, and - an inability to take into account the severe weakening of underwriting standards by certain originators.

October 2008 also saw the German government appoint Otmar Issing, former Chief Economist at the European Central Bank, to chair a committee to draw up recommendations first for the Group of Twenty (G-20) summit in Washington and then for the follow-up summit in London. The committees report drew attention to the part played by various unresolved conflicts of interests (Issing Committee 2008). It leveled the following criticisms at CRAs: The governance of credit rating agencies did not adequately address issues relating to conflicts of interests and analytical independence. Agencies competing for the business of rating innovative new structures may not have ensured that commercial objectives did not influence judgments on whether the instruments were capable of being rated effectively. Rating shopping by issuers contributed to a gradual erosion of rating standards among structured finance products. This negative effect resulted from the right of issuers to suppress ratings that they considered unwelcome, thereby exerting pressure on the agencies.

In March 2009, the United Kingdom (UK) Financial Services Authority published the Turner Review, which also highlighted the responsibility of CRAs in its analysis of the causes of the financial crisis. The review came to the following conclusions (Financial Services Authority 2009): The practice of making the models by which agencies rated structured credits transparent to the issuing investment banks created the danger that issuers were structuring to rating, i.e., designing specific features of the structure so that it would just clear a certain rating hurdle.2 The shift to an increasingly securitized form of credit intermediation and the increased complexity of securitized credit relied upon market practices that, while rational from the point of view of individual participants, increased procyclicality in the system. More securitization meant that a greater proportion of credit assets were held by investors seeking reassurance from credit ratings, and thus increased the potential aggregate effects of forced selling by institutions using predefined investment rules based on ratings.
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The use of market value or rating-based triggers increased in an attempt to improve investor and creditor protection. Arrangements that related the level of collateral posted in derivative contracts to the credit ratings of counterparties also had a significant procyclical effect.

In summary, the following elements may be said to have had an adverse influence on the quality of CRAs work: Overreliance on mathematical and statistical methodologies based on inadequate data,

Insufficient consideration of market and macroeconomic developments as factors influencing ratings, Failure to take account of interdependencies, Disregard of conflicts of interests, and Inadequate disclosure practices with regard to models and model assumptions.

This outline of the ratings dilemma would be inaccurate if it were to focus only on shortcomings on the part of CRAs. It is also true that investors often accepted ratings uncritically and overestimated their significance. Not enough attention was paid to the fact that ratings are only estimations of the relative probability of default or expected loss on a debt instrument. They are not a detailed assessment of risk and say nothing about an instruments price quality or liquidity. Ratings are no substitute for investment risk management, particularly as the information provided by CRAs is limited. In 2008, during the global financial crisis, rating agencies were chastised in congressional hearings and lawsuits for miscalculating the risks associated with mortgage-related securities. They were accused of creating complex models to calculate the probability of default for individual mortgages and also for the securitized products these mortgages made up. Raters deemed many of these so-called "structured" products top-tier triple-A material for several years during the housing boom, only to downgrade them to below investment-grade status when the housing market collapsed. In 2007, as housing prices began to tumble, Moody's downgraded 83 percent of the $869 billion in mortgage securities it had rated at the AAA level in 2006. Critics said the raters failed to judge the likelihood of the decline in housing prices and their effect on loan defaults. These inflated ratings also failed to account for the greater systemic risks associated with downgrading structured products, as opposed to simpler securities like corporate and sovereign bonds. Rating agencies also came under fire for allegedly sacrificing quality ratings to win a bigger share of the booming structured products business. By 2006, Moody's had earned more revenue from structured finance$881 millionthan all its business revenues combined for 2001. The Big Three argued that rating decisions were made by rating committees, not individual analysts, and that analysts were not compensated based on their ratings. As for the criticisms of the issuer-pays system, the agencies maintained that subscriber-pays raters suffered from their own conflicts of interest. Investors might pressure rating agencies for lower ratings because the securities, if deemed riskier, would pay higher yields. Short-sellers might also benefit financially
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from negative ratings. The real issue then, the Big Three argued, was not whether the system was issuer-pays or subscriber-pays, but how transparent raters were with the models they used.

5. The impact of Rating Agencies during the crisis in Europe Credit rating agencies aggravated the subprime crisis and also the financial crisis in Europe. In fact, having failed to predict the emergence of the crisis, rating agencies became excessively conservative. They downgraded European crisis countries more than the worsening in these countries' economic fundamentals would justify. Since 2009, the focal point of the financial crisis moved from USA into the European Union. The Eurozone was, and still is, the most vulnerable area as it is composed of countries whose economies have different resistance levels towards recession and the general decline in economic activity. Specifically, during the stability period of the global economy from the late 1990s until 2007, some Eurozone countries led the expansionary fiscal policy (with the inexistence of their own monetary policy, fiscal policy became the most important tool in guiding economic policy of the state). For example, the public debt of Greece, rose from 103.7% to 129.3% of GDP since 2001 to 2009, with an average budget deficit of 7.3% of GDP during the same period (according to The Pact of Stability and Growth, SGP, from 1997, the budget deficit must not exceed 3% of GDP and public debt must not exceed 60% of GDP annually, and if the mentioned value exceed these numbers, there ought to be a long-term tendency of reducing it values towards reference value). In the same period, the public debts of Portugal, Italy and Ireland recorded growth (51.2% to 83%, 108.2% to 115.5%, and 35.2% to 65.2% respectively) with a budget deficit of approximately 4.5 %, 3.4% and 1.6% in Ireland (where in 2009 the deficit amounted to 14.2% of GDP). At the same time, insufficient economic growth that had been for years pressured by a growing public debt, which generally directly affects the reduction of tax revenues and increases expenses due to the increase in social benefits, hampered the possibility of debt repayment of government debt securities issued in the period of expansion, when the yields on securities were lower and when due to the lack of perception of risk liquidity was sufficient to cover all individual state issues. From 2001 to 2011, the CRAs played a dual role in the European Union. Up to 2009, their credit risk ratings (e.g. Fitch rated Spain with AAA in the period 2003 to May 2010, although Spain has had problems with high unemployment and weak economic growth for many years; according to The Economist, in 2012 the Spanish economic growth will be negative and will amount to c.a. 0.8%) did not signal the creation of a new epicenter of financial crisis in Greece and the rest of the EU, i.e. in rating individual countries they did not take into account that despite structural economic differences, the economies of EU member states, and especially the Eurozone states, are strongly economically linked (as it is especially shown in the financial sphere and the case of Greece, where Greek debt creditors are mostly hard core EU countries and the Eurosystem; and that, by using the law of communicating vessels analogy, the crisis from one country will spill over to the rest of the Eurozone. After 2009, the CRAs reduced the ratings of those countries affected by the financial crisis disregarding the EU policy, particularly the European Council and European Central Bank efforts and activities (EC negotiations with creditors and the ECB purchase of Greek government bonds) that were aimed towards
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preventing the spreading of the crisis and thereby the preservation of the Eurozone and all its 17 states. Taking into account the primary objective of credit rating agencies, it was expected that the increased risks of certain countries will be expressed quantitatively through the reduced credit ratings prior to, and not after, entering recession (decrease in the rate of economic growth for two consecutive quarters).

6. The rating for Romania and Lithuania In this part of the paper, we tried to catalogue the types of country risk in which Romania and Lithuania are in. Levels of Risk D&B (Dun & Bradstreet) has identified three groups of countries, each with differing levels of risk. Higher Risk Countries Hungary, Latvia and Romania. These economies have run deep budget deficits, resulting from years of excessive public spending and a lack of reform to their extensive bureaucracies. This, allied to economic and financial crisis in late 2008, led these economies to seek support from the IMF; as a result, they must meet strict fiscal conditions in order to receive further installments from agreed rescue packages. Moreover, these countries are particularly vulnerable given the large proportion of FX denominated debt in total gross external debt. This exposes some of these economies to the current exchange rate risk and means dependence on financing from abroad. Romania seems particularly vulnerable to falling FDI, which dropped by more than 50% in 2009. Romania needs substantial foreign investment to boost recovery in its crisis-hit economy and (more importantly) to cover its extensive current account deficit: in January-April 2010 only 55.0% of the current account deficit was covered by FDI Moderate Risk Countries Bulgaria, the Czech Republic, Lithuania, Slovakia and Slovenia. Lithuanias economy contracted steeply in 2009 (real GDP fell by 14.8%), leading to a significant deterioration in the countrys fiscal position. Despite relatively low public debt (29.3% of GDP in 2009), we expect this level to rise rapidly during 2010-11 due to the countrys high borrowing requirements to finance its large budget deficit. Similarly, Bulgarias economic outlook remains challenging due to the reversal of the pre-2008 FDI boom, when large capital inflows generated greater credit accessibility and led to strong domestic demand. As such, the renewed slowdown in the euro area will increase the downside risks to our current growth forecast for Bulgaria. Moreover, the relatively strong position of Bulgarias public finances is offset by external financing vulnerability, in particular the private sectors high indebtedness (which exceeds 100% of GDP). In Slovenia, Slovakia and the Czech Republic economic growth prospects depend heavily on demand in Euroland due to their heavy integration in the European supply chain. Subdued
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demand in 2009 in the euro area led to a 7.8% contraction in Slovenias real GDP, and the mild growth we envisage for this year could be subject to downward revision. Similarly, Slovakia and the Czech Republic depend largely on the German and French automotive industries, which currently face reduced demand. Lower Risk Countries Estonia and Poland. Among the lowest risk countries is Poland, which thanks to its size (it is the biggest economy in the CEE region) and fortunate currency developments (the zloty depreciated on average by 23% in comparison to the euro in 2009) was the only European country to achieve economic growth in 2009. Despite this, its budget deficit widened to 7.1% of GDP, which will increase the borrowing requirement and inevitably raise public debt. That said, the government is committed to reducing its borrowing needs quickly, while reduced dependency on external demand will lead to another year of relatively strong economic growth. Although Estonias economy contracted by 14.1% in 2009, the government managed to achieve a budget deficit of only 1.7% of GDP, enabling the country to meet the economic conditions for euro entry. This was due to the large fiscal cuts implemented throughout the year; however, these will further undermine domestic demand and delay the economic recovery. Nevertheless, Estonias membership of the single currency (possibly in 2011) will bring medium-term benefits to the country, especially given its low public debt (the lowest in the EU in 2009).

The attractiveness of a state regarding foreign investors, multinational banks and creditors, is closely related to country risk assessment. Most of the financial and economic rating agencies such as Standard & Poor's, Fitch, Moody's, etc., are in a position to analyze, more or less subjectively, more or less reliable, country risk developments. Rating systems that appear as important tools in decision-support are taken, in many cases non-critically, by the decision makers and used as such. The process of globalization has multiplied the country risk acceptance
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and successive crises with recurrence, often without advance, stressed that the assessment processes has significant shortcomings. ROMANIA

Overview of the ratings 1998-2013 In the late 90's the financial system reform took place, during which the process of catching up has intensified and because of that the ratings for Romania changed. Romanian economic recovery started after 2000 was an effort supported by increased investment by both domestic funds as well, especially by foreign funds, namely foreign direct investment. Romania (whose rating was upgraded to A4 in 2005) has posted enviable growth performance even if a slowdown has developed due to floods, slower export growth and increased demand for imported goods. Although company payment behavior has certainly been characterized by frequent delays, they often result in collections. The external account deficit has widened. However, capital inflows, notably FDI, have increased, generating a sharp rise in foreign exchange reserves. The country joined the EU in 2007. Although the progress made on justice and competitions policy has been encouraging, there are still shortcomings to remedy. For example, in the real convergence has been an imbalance because of the transition process. This process has not always been well managed and the process of "catching-up" cannot be achieved if the real convergence indicators arent sustainable. In 2007, S&P downgraded the rating for Romania for foreign currency loans from BBB- to BB+ and also for long run loans in lei to BBB- as a result of risks related to financing. This had an impact on Romanian economy because weaken the national currency and increased the cost of external financing. Instead, the agency has maintained the rating A-3 for short term loans in lei and because of that the loans in lei had increased and as a result of the crisis at the end of 2008, the level of non-performing loans reached 18%. The rating for transfer and convertibility was downgraded from A- to BBB+ because of the high debt in the private sector and the addiction which is arising from foreign funding sources that are more and more uncertain. The main argument for downgrading Romanias rating from stabile to negative is because of the deepening of external imbalances, on the basis of global credit turmoil. Even though Romanias banking system isnt as developed as it is in the western countries, it had problems regarding the NPL. From this point forward, Romania became a risky country for the investors according to S&P and Fitch Ratings. These two agencies pulled Romania outside the rating category with investment recommendation because of larger issues on the side of private external debt. Also, Romanaia started to have a high risk because of high budget deficit. Even though, the rating agencies had a role in triggering the subprime crisis because they gave high marks to investment products that proved risky, they still remain very influent in the
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economic environment. Due to this fact, the rating agencies decisions may influence directly the evolution of the exchange rate (iese capital din tara, valuta se depreciaza) and the state borrowing costs (tara devine mai riscanta, ar putea sa nu fie capabila sa-si plateasca datoriile) and indirectly, the cost of credit to the private sector (rata dobanzii creste cu scopul de a scade nivelul creditelor private => riscul creditelor neperformante). At the end of 2008, this situation worsens and the rating agencies are aggressively lowering the rating with two points as a cause of Romania's external imbalance, mainly because the private sector, represent a major risk. Unfortunately, after the crisis outburst in 2008, the ratings of Romania have deteriorated. In November 2008, Fitch and Standard and Poor's credit agencies cut Romania's rating to "junk", worried by its large current account deficit and reliance on short-term borrowing. Only Moodys has maintained the same rank of rating for Romania. The advantages and disadvantages with which Romania entered in the crisis concerns: high budget deficit (meaning the structural budget deficit is at alarming levels), stable banking system, lack of toxic assets as a result of poor diversification of banking services. The impact of low ratings are felt in: lower levels of production and export, the foreign investment flow decreased, increasing in the cost of lending and foreign funding, increased government deficit and external. Hopefully, after one year and a half, in April 2010, Fitch Ratings raised the outlook on its BB+ credit rating to stable from negative. In March 2010 - Romanias credit rating outlook was raised to stable by Standard & Poors after the International Monetary Fund resumed a bailout loan to the country and the government passed an austerity budget. Moodys Investors Service, remained the only agency to rate Romania as investment grade. Standard & Poor's changed its outlook on Romania to stable from negative due to the government's success so far in undertaking fiscal consolidation. The Romanian government has been successful to date in implementing its fiscal consolidation program. The improved outlook for Romania also reflects that the country is likely to continue to comply with the IMF/EU standby agreement, thereby further easing external financial pressures. On medium run the effect of entering into the investment grade it led to the appreciation of the national currency, lowering the cost of funding and also the increasing in the investment in capital market. The improvement in the Romanias rating was motivated by a number of macroeconomic factors such as the return to economic growth, stabilize the current account deficit and budget deficit. This shows that both market and rating agencies react to improving macroeconomic fundamentals. Also, it is visible a certain interta of the rating from market conditions; investors react quickly to changes in the economic situation while the rating agencies have a slower reaction, rating changes usually took place long after the trend began already to manifest. According to this, improving the rating caused an increase in the attractiveness of local bonds to investors, and a decrease in finance costs in the state market, currency appreciation.

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According to Bloomberg, Romania has been among the best performers in the world in terms of reducing the country risk in the third quarter of 2010. Thus, Romanian sovereign bond risk fell by 21.5 points, reaching a lower than 300 points psychological level. In comparison, several European Union countries have experienced increases in country risk, such as Ireland and Greece, which recorded increases of up to 640, 1023 points respectively. In 2011 representatives of S&P announced that for Romania, the passage of the attribute negative to stable is closely related to assessors of reforms agreed with IMF. Currently valued at BB+, Romania is below the recommended level for investment. After overheating and a hard landing, economic recovery from a deep recession is taking a long time to arrive. In 2012, the Government instability has often affected sound policymaking and reform process. In 2013, Romania has struggled to shed its junk rating for five years, embarking on one of the European Unions toughest austerity programs in 2010 by cutting state wages 25 percent and raising value-added tax by 5 percentage points. The government secured a third international bailout loan this year and has narrowed the budget gap to an estimated 2.5 percent of gross domestic product this year, from 7.2 percent in 2009. Romanias macroeconomic reality not only justifies the outlook improvement but also a rating upgrade. Fitch Ratings has affirmed Romania's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB-' and 'BBB', respectively. The Outlook on both ratings is Stable. Fitch has also affirmed Romania's Short-term rating at 'F3' and Country Ceiling at 'BBB+'. - Public finance consolidation. Romania has consolidated its public finances successfully under two consecutive international financial assistance programs. - Reduction of external imbalances. Romania ran a current-account surplus. The agency believes that this improvement is partly cyclical. - Safety buffers. Romania possesses buffers in the form of a fiscal reserve in foreign currency. Fitch judges that these would be sufficient to withstand a significant degree of market turbulence. - Low, albeit improving trend GDP growth. Nevertheless, average GDP growth appears insufficient to reduce meaningfully the gap with average EU incomes. This is because of lingering bottlenecks in the Romanian economy, namely inefficient state-owned enterprises (SOEs) in key sectors such as transport and energy, and underperforming healthcare and public administration. In late July Romania, the IMF and the EU concluded the outline of a new precautionary financing deal that is likely to focus on the implementation of structural reforms in the aforementioned areas. - Stable but constrained banking sector. The banking sector remains well capitalized and supervised, and has returned to profitability. Nevertheless, the non-performing loan (NPL) ratio is high at 20.9% in July 2013 and has yet to peak, although the pace of NPL creation has slowed
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and prudential provisions fully cover the NPL stock, according to data from the National Bank of Romania. The absence of an effective framework to clean up banking balance sheets combined with ongoing deleveraging impairs monetary policy transmission and represents a significant obstacle to the resumption of credit growth. - EU membership underpins domestic politics and institutions, and governance standards are in line with the category median. The political scene has stabilized in 2013 after a turbulent 2012 but EU parliamentary and presidential elections are scheduled for next year and a degree of instability could return. The main risk factors that, individually or collectively, could trigger a positive rating action are: - A sustained effort to carry out structural reforms, including the sale or restructuring of key SOEs that leads to stronger sustainable economic growth. - Faster reduction in external debt ratios than Fitch currently expects. The main risk factors that, individually or collectively, could trigger a negative rating action are: - A significant fiscal loosening that jeopardizes the stability of public finances.

LITHUANIA

Overview of the rating 2002-2013

2002 for Lithuania - this year is crucial for the country in terms of its membership in the European Union and NATO. The financial and economic development has been quite
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satisfactory. Certain economic indicators have outpaced even the most optimistic projections(sectors like construction, transport and storage, hotels and restaurants and even agriculture). Macroeconomic performance was better than expected in 2001-2002, GDP growth rate was driven by fast growing exports and investments, while the impact of slowdown in the EU was insignificant and largely offset by strong demand from CSI countries. The situation of external debt an liquidity strengthened and the credit to the private sector initiated a strong recovery. 2004 is the year when Lithuania enters the EU. Lithuania met all the nominal criteria, and improved its economic performance, it also became very attractive to foreign investors ( FDI tripled in 2004), thats why the all the rating agencies improved the rating for this country. In 2005, the economic performance, was still improving, it registered an economic growth of 7,5%. This generated another increase in the country rating, and it remained stable until the end of 2008. Lithuania was the last among the Baltic States to be hit by the economic crisis because its GDP growth rate in 2008 was still positive. In 2008 the country risk dropped down, due to the economic crisis. This was a worldwide phenomenon. The figures made Lithuania the worst performing economy in the EU in 2009, so the rating downgraded again. From 2009 and until present the rating remained the same, it is a stable one.

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7. Comparison/analysis of their decisions ROMANIA

In this time period, rating agencies took the same decisions with the only difference that the decision is taken with a lag. This lag is explained by their unique mode of evaluating (see chapter 3). In 2011, the difference between BBB and BB+ is a way of expressing the loan risk. BB+ is the level where the people cannot have trust anymore. The rating influences the investors decisions whether to invest in a country or not. Thus, the rating influences the level of the CDS, meaning the costs where the sovereign bonds are insured against default risk (part of the cost of international lending. In 2011, S&P upgraded the rating for Romania from BB+ to BBB- due to the fact

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LITHUANIA

We can see that the decisions that have been taken by these rating agencies were quiet the same. If there were some differences, the lag between them was not more than a year, and in the end the decisions were the same (these small differences have technical, but not economic reasons). 8. Were their decisions right or not regarding the ratings Romania and Lithuania The ratings on countries are two types: - When expresses a current situation given by the analysis made by rating agencies - When expresses a forecast of economic situation (this can be accurate or not, depending on the development of the country) On this second type, the impact of rating on economies can be associated with anticipations. For example when a country forecasts an upgrade on its budgetary deficit, the country may or not accomplish this forecast. This depends on the strength of the economy and the policies applied. Most of these forecasts werent accurate, and because of that Romania and Lithuania had some difficulties. Also, the ratings of current situations didnt show the reality, they were too confident. Because Romania had almost 7 years a growth stimulated by a greater dynamic domestic demand, at the beginning of the crisis, the rating agencies couldnt predict the tension that has developed due to macroeconomic imbalance. So, they changed the rating only at the end of 2008 when all economic indicators were already started to decrease. In my opinion before the crisis the decisions of the rating agencies were not quite accurate. They took in account strictly the nominal and the quantitative side of the economic performances of these two countries. For example for Romania, in the years before the crisis, the most important wheel of economic growth was the consumption which is not a sustainable one, and everyone knew that eventually it is going to crush, but still, the country rating kept going up. Of course, in
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2009 the rating agencies had to downgrade the country, but this led to a vicious circle. When Romania was deeply affected by the crisis, a lower country rating emphasized its instability, which deepened the negative effect of the crisis in the following years. !!!DIa 9. Conclusions

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