Sovereign Credit Ratings Revealed
June 21st, 2011 at 5:49 pm - by Lindsay Amantea
Often when the media is talking about the economic status of a country there will be mention of the sovereign credit rating. However, it is assumed that individuals understand what these ratings mean precisely as well as how they are arrived at. This is a brief outline of what the ratings are and how they are arrived at.
Sovereign credit ratings are like credit scores for individuals or businesses, but they assessments for the government of a country. Like individuals governments lend and borrow money from banks, from each other and from institutions like the International Monetary Fund. Ratings indicate the risk that lenders take in letting governments borrow money. In other words, it is the level of risk that they take that they will not get their money back. Sovereign ratings take into account not only previous history but political risks. These risks can include change of ruling government as well as probably of the government being overthrown.
There are three credit rating agencies that are used for sovereignty ratings, Standard & Poor’s, Moody’s and Fitch Ratings. Each agency has a different scoring scale, but all use a letter grading system. S&P’s system, from best to worst is: AAA (prime), AA+, AA, AA-, A+, A, A-, BBB+(lower medium grade), BBB, BBB-, BB+, BB, BB-, B+ (highly speculative), B, B-, CCC+ (substantial risk), CCC, CCC-, CC, C, and D (complete default). Moody’s ratings range, from highest to lowest: Aaa (prime), Aa1, Aa2, Aa3, A1, A2, A3, Baa1 (lower medium risk), Baa2, Baa3, Ba1, Ba2, Ba3, B1 (highly speculative), B2, B3, Caa1 (substantial risk), Caa2, Caa3, Ca, and C (complete default). Fitch’s system, from top to bottom, is: AAA (prime), AA+, AA, AA-, A+, A, A-, BBB+ (lower medium risk), BBB, BBB-, BB+, BB, BB-, B+ (highly speculative), B, B-, CCC (substantial risk), DDD, DD, D (complete default). Moody’s and Standard & Poor’s are both based in America while Fitch Ratings is based in France.
One other ratings agency, Dagong which is based out of China, has released a list of sovereign credit ratings. These are radically different than the ratings given by the big three, and it is much cause for debate. Dagong has also accused Western credit agencies with no longer maintaining their objectivity when dealing with sovereign ratings, and thinks that this bias translated to slowness in downgrading some countries in the global financial crisis. It can be read about here.
These ratings affect the borrowing rates for countries. The higher the rating, the lower the risk, and therefore the lower costs and interest rates associated with a loan. This can affect the amount of money that a country can borrow, and how long it will take them to pay it back. Countries like Norway, which has the highest sovereign credit rating in the world, spend less in interest when they receive a loan than countries like Greece, which is likely to default on its current loans. As well, often changes in ratings will be accompanied by an ‘outlook’, letting corporations and the media know which direction the ratings agency thinks that any further changes will trend.
A strong grasp of credit ratings is important in understanding how much deficit spending affects a nation’s future as well as how much defaulting on a loan can change future government’s abilities to finance deficits. While abstract, this concept has many implications for a government’s finances and public policies.