A sovereign credit rating is the credit rating of a country or sovereign entity. A Credit rating is nothing but the assessment of a borrower in terms of its creditworthiness, i.e. their ability to repay debt, mainly with respect to a particular debt or financial obligation.
Why a credit rating is assigned
A credit rating can be assigned to any entity that seeks to borrow money. It can be an individual, corporation, state or provincial authority, or sovereign government. Rating and assessment helps the prospective investors in accessing the risk associated with investment in a particular country, thus helping them in deciding their future plans.
Therefore, it becomes of high importance for developing countries as they need good sovereign ratings in order to access funding in international bond markets.
For companies and Government, credit assessment and evaluation is generally done by agencies like Standard & Poor’s, Moody’s or Fitch. They assess economic, political environment of the country to judge its economic stability.
They are paid by the entity that is seeking a credit rating for itself or for one of its debt issues, which in turn helps the country in:
How it works
Different rating agencies have their distinct rating scale or terminology to describe the credit-worthiness of issuers.
The bifurcation of short term and long term is done on the basis of likelihood of the related party to go into default within one year or above one year respectively. In the past institutional investors preferred to consider long-term ratings which is being replaced nowadays, by short-term ratings now-a-days.
Why is it important?
In a normal cycle of operation, government spends on different welfare and development activities through the money generated by public, mainly in form of taxes.
However, if the raised money is not sufficient enough, external investment is sought in form of bonds, treasury bills etc. So naturally, a good sovereign rating is helpful in attracting sufficient investment, which in turn is used for country’s welfare.
Also the ratings help in deciding the cost of borrowing. As government tend to be the largest and safest borrower in a country, their rating acts as the benchmark for other issuers of debt in the country too.
As a consequence, the upgrading or downgrading of sovereign credit ratings can impact the cost of borrowing for companies, individuals who wants to raise money in the overseas market.
The sovereign rating needs to be monitored prudently through well-planned monetary and fiscal policies, in order to ensure investors’ trust and in turn economic stability in the country, as is a very important indicator of the country’s financial and fiscal health.