What are sovereign debt credit ratings ?

Yesterday, India’s sovereign debt credit rating was downgraded by rating agency Standard & Poor. At the back of that, I wanted to do a basic article on what a it is, what it represents and should investors on the ground be a worried lot.

Will this rating affect your financial planning and should you take any measures ? And finally the poll !

The basics first

Like a CIBIL report measures an investor’s credit worthiness, a country’s ability to pay back debt is also very important and is measured by sovereign debt credit ratings. Someone ought to measure that. That is where international rating agencies come in.

These agencies rate the credit worthiness of governments across the globe – simply defined this is the ability of the government to pay back debt that it is taking on and whether it will default or not.

The ratings are of 3 kids – positive outlook, stable and negative. India was yesterday downgraded to negative from stable.

The ratings denote a government’s ability to meet their future financial liabilities given all the risks it goes through every day – be it market, political or economic.

Credit rating is usually of a financial instrument such as a bond and usually never of the whole corporation.

The largest credit rating agencies are Moody’s, Standard & Poor’s, Fitch Ratings and Dun & Bradstreet.

The Standard & Poor’s rating scale is denoted as below.

Standard & Poor’s from excellent to poor : AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, C, D.

Anything lower than a BBB- rating is considered a junk bond.

The Moody’s rating system is similar but the naming is different.

Moody’s from excellent to poor : Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C.

Sovereign Debt Rating Agencies

How does it impact the country and investors ?

Since the ratings are a measure of a nation’s ability to pay up debt, any future debt that the country wants to take will not come cheap. That is because lenders will now view that country as a risky borrower. They will doubt the nation’s capability to repay back principal and pay interest on it.

India does not borrow from foreign markets but Indian companies do via ECBs – External Commercial Borrowings. An external commercial borrowing (ECB) is an instrument used in India to facilitate the access to foreign money by Indian corporations and PSUs.

Hence any future borrowing that we do will be at higher rate of interest and will hurt profitability, that could potentially mean a depressed market, both equity and debt.

India’s policy paralysis, large fiscal deficit, heavy debt burden and numerous scandals have forced S&P to downgrade India. In fact, it warned that in the next two years, India could be downgraded to the “junk” investment category if this continues.

Should this happen, FIIs will obviously not invest in India if the view was it was junk !

The ratings will improve if the government improves the investment climate in the country, reduces the huge deficit and implements policies that have been pending for so long now.

Expect some short term turmoil on the stock markets as investor’s sentiments are impacted. And don’t get worried to death as S&P is viewed as a jumpy rating agency as compared to Moody’s. Continue your financial life as is !

So finally, here is the poll you can take and vent your thoughts on whether the rating will improve or downgrade in the near future.

Author: Radhey Sharma

Radhey is a Certified Financial Planner and an expert in the disciplines of insurance, retirement, investments and tax. His hobbies include gardening, traveling and reading self development books. The information contained on this blog is general advice and may or may not be suitable to the reader. Kindly take professional help before you apply what you read.

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28 Comments

  1. In current political situation its tough task for government to take any steps of reform. But government has its own compulsion. Its own allies are creating problem for them.

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  2. Thanks for writing this article, I learnt something new today.

    I think the rating will move back to stable soon. There could be a thousand differences between the politicians but there is one thing that bind them together i.e. money and power. They know if rating deteriorates they will start losing on their money and power, which they simply cannot let happen. Some patch work will be done to get the rating back to stable and then BAU from there on i.e. fights, scams etc.

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    • I also believe the rating will come back to stable soon.

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    • I don’t think this government has much time to think on that. They are busy handling president election and 2014 election (how to get more votes), how they would manage their seats under new leader ;). Stoppping here not to divert topic ;). Anyway they were aware about this warning would happen at some time by seeing the (deficit) data. Though they will be forced to do something if they can really do.

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  3. I was disappointed by the ratings. India is in much better shape than US and many European countries. When US was downgraded you saw how they reacted and in fact after few days the head of S&P (an Indian) stepped down. What US and European countries are doing is just printing $$$$$, that will not help.

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    • Thats’ the power of being a developed nation. India has a long way to reach there.

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    • Yes, in that sense, Moody’s has not pressed the panic button, only S&P has.

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  4. Well..this is all politics..this is a game western capitalist economies plays well…US and its allies not happy with Pranab Da due to some political decision he has taken regarding Iran, retrospective tax etc which USA and its allies obviously did not like and hence the retaliation..now everyday you will read negative stories,opinions,polls in western media about india until India either clarifies its stand OR Pranab Da steps down…well i think until next elections you will keep listening negative stories and then everything will settle down. This is my personal opinion..:)

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    • If I go by the reasons given in this article to downgrade rating i.e. policy paralysis, large fiscal deficit, heavy debt burden and numerous scandals, not sure how this is the conspiracy of western economies?

      These are the facts and unfortunate environmental factors of our country. Unless we come out this it will be difficult for India to earn positive outlook rating irrespective of any “conspiracy”.

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      • There are many parameters on which the outlook and rating of a country is based. That is not covered in the article but you are right that the reasons why the outlook changed is more of less the same as mentioned above.

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  5. informative article. Its fascinating how these issues affect the stock market and hence portfolio growth. There is only one thing for the lay investor like me to do.

    Say the serenity prayer used by alcoholic anonymous groups:

    God, grant me the serenity to accept the things I cannot change,
    Courage to change the things I can,
    And wisdom to know the difference.

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    • Lol Pattu, good one that.

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  6. Nice informative article. I am mostly concerned about the high real estate price in India which is constantly on the rise for last 8 years, i just hope the end user doesnt lose her money if India gets a negative rating.

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  7. Hi,
    If you may allow, I may want to point to some additions to this article.
    1. The rating of India was not downgraded. It was a rating outlook which changed to negative.
    2. Credit ratings of a country gets associated with the companies of the country. Based upon a credit rating, investment banks assign their credit limits upto which they would want to trade with a company in that country.
    3. Similarly every country is assigned a trading credit limit which is monitored against total credit exposures which an investment bank as with that respective country. These are also termed as Concentration Risks.
    4. Hence with lowering of a credit rating by a credit rating agency such as S&P, the respective credit limits associated with the country and the companies in that countries gets revised (downwards). This results in liquidating some credit exposures which the investment bank would have against that country. And finally that liquidation action results in selling in stock markets in India.

    Regards
    BanyanFA

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    • Yeah, you are right, the rating wasn’t downgraded, only the outlook was.
      Thanks for your gem of a reply, really useful and good learning.

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    • Thanks for additional inputs BFA. Could you please tell what’s the difference between rating and rating outlook? Also, is there any difference in the impact?

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      • Hi Vivek,
        Rating outooks are slightly different in terms of their actual impact. They reflect that if the current situations do not improve, the a negative outlook may result into a rating downgrade. It just brings the respective country / company on a more frequent / high risk radar. It is the actual downgrade which results into a of chain events.

        Regards
        BanyanFA

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        • Ok, thanks. So if actual downgrade happens then we could be in trouble. As of now it is a warning of a thunderstorm.

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          • Exactly.

        • Looks like time to move from equity to debt funds. FII’s will be the first ones to run away. Moreover they have been net sellers in Sensex over the last few days, its the DII’s who are buying is keeping the market afloat.

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          • Are you seriously moving your money from equity to debt?

    • Standard replies: “shocked, don’t panic, we will come back soon!”

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  8. Picture looks gloomy though, FII’s have withdrawn in excess of 700 crores this month (which is quite less though). Even this quarter results failed to bring cheer in the street. We need some good positive news fast, Will keep fingers crossed.

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  9. Last time India was downgraded was in early 2009 after that market bounced back sharply. Are we seeing a similar trend?

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