Just like companies are rated by rating agencies so are countries rated.
Let’s understand how this is done.
Sovereign ratings are needed for those who plan to invest in a foreign country. If the country does not enjoy a good rating, such investments are considered risky.
Till 2008 sovereign default was not considered a real concern. The debt crises began in 2008 with the collapse of Iceland’s banking system, then spread primarily to Portugal, Italy, Ireland, Greece, and Spain in 2009, leading to the popularization of a somewhat offensive moniker.
Argentina, Lebanon, and Ukraine are among the countries that have defaulted on their debt in recent years. The causes of a default can range from high debt burden and economic stagnation to political instability or a banking crisis.
In November 2017, Venezuela — which has the world’s largest oil reserves — is declared to be in partial default by rating agencies Fitch and S&P.
Recently we have seen Srilanka defaulted on its $51Billion External Debt, calling the move a “last resort” after running out of foreign exchange.
So how are countries rated.
This process is a little different from how companies are rated.
Just as in the case of a company, even for a country there are several quantitative parameters that suggests the health of the economy.
However, unlike a company rating, in the case of rating a country, higher weightage is given to other qualitative parameters.
Some quantitative parameters which indicate the countries abilities to pay its debt are :-
- Debt/GDP
- Current account deficit
- Interest amount/Expenditure
- Economic growth rate
- Savings rate
- Investment rate
The country’s ability to withstand financial shocks are also investigated – whether banks have been subjected to stress tests and how they have emerged from such tests.
Besides quantitative measures the rating agencies interview policymakers to assess the policies being planned and the countries outlook towards financial reforms.
Analysts also make a judgment of the political risks that prevails such as probabilities of an external war, internal unrest, terrorism threats etc.
Thus, while the quantitative parameters become the inputs into some sort of “mathematical model” to assess the country’s credit worthiness while the qualitative parameters which examines risk environment prevailing there.
Thus, sovereign rating essentially assesses the country’s government. In this context it’s interesting to note that US has a AAA rating and India’s rating is BBB- while the outlook is ‘stable’ for both of them (S&P Ratings).
The rating given to a country becomes the benchmark for ratings granted to other financial instruments like corporate bonds etc.
Since granting rating to a country has massive implications for the subject country, a large element of mature judgment is needed.