21 Nov 2017 14:59 IST

All you wanted to learn about Sovereign Ratings

Sovereign ratings decide the cost borrowings

The Government and stock investors alike cheered last week when Moody’s, one of the top global credit rating agencies, raised India’s sovereign issuer rating to Baa2 from Baa3 with a ‘stable’ outlook. It attributed the revision to policy and institutional reforms and the long-term prospects being bright for the country. While one camp of commentators has welcomed the upgrade as long overdue, the other camp has questioned its timing — the economy is being roiled by slow growth, the aftermath of the note ban and transition to GST.

What is it?

We all know that credit scoring and rating agencies rank individuals and companies on their ability to repay debt. Well, global credit rating agencies assign similar rankings to entire countries, which are termed as their sovereign bond ratings. Governments of countries earn income by way of tax collections, cess, profits from State enterprises and other avenues. They spend money on administration, subsidies and welfare schemes. Now, governments, like many of us, often end up spending more than they earn and end up borrowing to make up the shortfall. They issue bonds, treasury bills and notes to borrow and promise to repay interest and principal at a later date.

Different rating agencies have differing rating scales or terminology to describe the credit-worthiness of issuers. Note that, in Moody’s rating, scale, bonds rated Baa3 and above are considered to be investment grade, meaning, these bonds are likely to meet the payment obligations better. India was at the lowest rung of the investment grade until it received this upgrade.

Agencies also append numbers to ratings to indicate the relative position within a category. For instance, ‘Aa1’ indicates that the issuer ranks at the higher end of its category, while ‘Aa2’ indicates mid-range ranking and ‘Aa3’ indicates a ranking in the lower end.

Why is it important?

For governments that lean heavily on borrowings to run the fisc, sovereign ratings decide the cost borrowings. As governments tend to be the largest (and safest) borrowers in a country, their rating acts as the benchmark for other issuers of debt in the country too. Effectively, sovereign upgrades or downgrades can affect borrowing costs for companies, individuals and pretty much any entity looking to raise money in the overseas market.

While our government doesn’t really borrow a lot in the overseas market, the sovereign rating is still an important indicator of the country’s financial and fiscal health. Foreign investors looking to commit money to direct investments, portfolio investments or local bond markets will all tend to look to the sovereign rating for a quick assessment of the country’s prospects. For governments, rating views by global agencies can also act as moral suasion that encourages them to pursue prudent monetary and fiscal policies.

Why should I care?

Rating upgrades or downgrades are usually events to watch for investors. This time around, the stock markets managed a mild jump after the news of the rating upgrade, while bond markets did not witness any major reaction. In the short run, therefore, this upgrade hasn’t really delivered a boost to your wealth. But over the longer term, if this upgrade does manage to lower borrowing costs for Indian companies, some companies in your portfolio could see lower interest outgo.

The bottomline

Moody’s has lifted the investor mood for sure. But it is anyone’s guess as to whether it will matter to the electorate.

(The article first appeared in The Hindu BusinessLine.)