Sovereign Ratings

Sovereign Ratings

Subject :Economy

Section: Capital Market

Concept :

Sovereign credit rating is an assessment of a country’s creditworthiness. It shows the level of risk associated with lending to a particular country since it is applied to all bonds issued by the government. Generally within the country treasury bills or bonds issued by the government are considered zero risk investment, but for international creditors, there is a perceived risk as in certain situations even national governments may become insolvent, as was seen recently with Sri Lanka and Pakistan. This may happen because of a lack of forex reserves, unsustainable government debt. Hence Sovereign Ratings become important.

Factors:

Credit rating agencies consider various factors such as the political environment, economic status, and its creditworthiness to assign an appropriate credit rating. Obtaining a good credit rating is important for a country that wants to access funding for development projects in the international bond market. Also, countries with a good credit rating can attract foreign direct investments.

The big three rating agencies are: Moody’s Services, Fitch Ratings, and Standard & Poor’s. Several factors such as following determine a country’s sovereign rating:

• Per capita income
• GDP growth
• Rate of Inflation
• External debt
• Economic development
• History of defaults

The chart below shows the rating system of the three agencies.

S&P has recently maintained ‘BBB-’ (triple B minus) with ‘stable outlook’ rating for India, which means that it is just above BB ie. speculative grade rating.

With regards to factors that influence India’s rating, we see following:

Rating Agencies

• A rating agency is a company that assesses the financial strength of companies and government entities, especially their ability to meet principal and interest payments on their debts.
• The rating assigned to a given debt shows an agency’s level of confidence that the borrower will honour its debt obligations as agreed.
• The Big Three Credit Rating Agencies: Fitch Ratings, Moody’s Investors Service and Standard & Poor’s (S&P) are the big three international credit rating agencies controlling approximately 95% of global ratings business.
• In India, there are six credit rating agencies registered under SEBI namely, CRISIL, ICRA, CARE, SMERA, Fitch India and Brickwork Ratings.

Role of Rating Agencies in Capital Markets

• Rating agencies assess the credit risk of specific debt securities and the borrowing entities. In the bond market, a rating agency provides an independent evaluation of the creditworthiness of debt securities issued by governments and corporations.
• Rating agencies also give ratings to sovereign borrowers, who are the largest borrowers in most financial markets.
• Sovereign borrowers include national governments, state governments, municipalities, and other sovereign-supported institutions. The sovereign ratings given by a rating agency shows a sovereign’s ability to repay its debt.
• The ratings help governments from emerging and developing countries to issue bonds to domestic and international investors.
• Governments sell bonds to obtain financing from other governments and Bretton Woods institutions such as the World Bank and the International Monetary Fund.