Sovereign Credit Rating

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Sovereign Credit Rating

What Is a Sovereign Credit Rating?

A sovereign credit rating is an impartial evaluation of a country’s or sovereign entity’s creditworthiness. Sovereign credit ratings may provide investors with information into the amount of risk involved with investing in a certain country’s debt, including any political risk.

A credit rating organization will examine the country’s economic and political climate at the country’s request in order to award it a rating. Obtaining a solid sovereign credit rating is often required for developing nations seeking financing in international bond markets.

KEY TAKEAWAYS

  • A sovereign credit rating is an impartial evaluation of a country’s or sovereign entity’s creditworthiness.
  • Investors use sovereign credit ratings to determine the riskiness of a country’s bonds.
  • Standard & Poor’s considers nations with ratings of BBB- or above to be investment grade, while ratings of BB+ or below are considered speculative or “junk” grade.
  • Moody’s deems a Baa3 or above rating to be investment grade, whereas a Ba1 or below rating is considered risky.

Understanding Sovereign Credit Ratings

Another typical reason for governments to get a sovereign credit rating is to attract foreign direct investment, in addition to issuing bonds in external debt markets (FDI).To boost investor confidence, several governments seek ratings from the biggest and most recognized credit rating firms. The three most prominent agencies are Standard & Poor’s, Moody’s, and Fitch Ratings.

China Chengxin International Credit Rating Company, Dagong Global Credit Rating, DBRS, and Japan Credit Rating Agency are some more well-known credit rating companies (JCR).Subdivisions of nations may issue their own sovereign bonds, which must also be rated. Many organizations, however, exclude smaller territories, such as a country’s regions, provinces, or municipalities.

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Investors use sovereign credit ratings to determine the riskiness of a country’s bonds.

Sovereign credit risk, as represented in sovereign credit ratings, denotes the possibility that a government would be unable—or unwilling—to pay its financial commitments in the future. Several significant elements come into play when determining how dangerous it is to invest in a certain nation or area. They include its debt service ratio, domestic money supply increase, import ratio, and export revenue variation.

Following the 2008 financial crisis, several countries faced rising sovereign credit risk, sparking worldwide debate on the need to bail out whole nations. At the same time, other governments accused credit rating firms of downgrading their debt too quickly. The agencies were also chastised for operating on a “issuer pays” basis, in which governments pay the agencies to grade them. If investors paid for the ratings, these possible conflicts of interest would not exist.

Examples of Sovereign Credit Ratings

Standard & Poor’s considers nations with ratings of BBB- or above to be investment grade, while ratings of BB+ or below are considered speculative or “junk” grade. Argentina received a CCC- rating from S&P in 2019, whereas Chile retained an A+ rating. Fitch has a method that is comparable.

Moody’s deems a Baa3 or above rating to be investment grade, whereas a Ba1 or below rating is considered risky. Moody’s assigned Greece a B1 rating in 2019, while Italy obtained a Baa3 rating. In addition to letter grades, each of these organizations provides a one-word evaluation of each country’s present economic outlook: good, negative, or steady.

Sovereign Credit Ratings in the Eurozone

The European debt crisis lowered several European countries’ credit ratings and resulted in Greece’s debt default. Many sovereign states in Europe abandoned their own currencies in favor of the euro, the single European currency. Their national currencies are no longer used to denominate their sovereign obligations. To prevent defaults, eurozone nations’ national central banks cannot “create money.” While the euro enhanced commerce between member countries, it also increased the likelihood of nations defaulting and lowered numerous national credit ratings.

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