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.
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.