What is a Sovereign Credit Rating?
A sovereign credit rating is an independent assessment of the creditworthiness of a country or sovereign entity. Sovereign credit ratings can give investors insight into the level of risk associated with investing in the debt of a particular country, including any political risk.
At the request of the country, a credit rating agency will evaluate its economic and political environment to assign it a rating. Obtaining a good sovereign credit rating is usually essential for developing countries that want access to funding in international bond markets.
Understanding Sovereign Credit Ratings
In addition to issuing bonds in external debt markets, another common motivation for countries to obtain a sovereign credit rating is to attract foreign direct investment. To encourage investor confidence, many countries seek ratings from the largest and most prominent credit rating agencies, such as Standard & Poor's, Moody's and Fitch Ratings, which dominate the market. Smaller, but still well-known, rating agencies include China Cheng Xin International Credit Rating Company, Dagong Global Credit Rating, DBRS and Japan Credit Rating Agency (JCR). Subdivisions of countries may also issue sovereign bonds, which require rating; however, many major agencies exclude smaller areas, such as a country's regions, provinces, or municipalities.
Investors use sovereign credit ratings as a way to assess the riskiness of a particular country's bonds.
Sovereign credit risk, which is reflected in sovereign credit ratings, represents the likelihood that a government might be unable—or unwilling—to meet its debt obligations in the future. Key factors that come into play in deciding how risky it might be to invest in a particular country or region include its debt service ratio, growth in its domestic money supply, its import ratio, and the variance of its export revenue, among others.
During the Great Recession in 2008 many countries—most notably, Greece—faced growing sovereign credit risk, stirring global discussions about the possibility of having to bail out entire nations if they were not able to repay their debts. At the same time, the credit rating agencies were accused by some countries of being too quick to downgrade their ratings, thereby exacerbating the crisis. The agencies have also been criticized for following an "issuer pays" model, in which countries pay the agencies to rate them (rather than investors paying for those ratings), setting up a potential conflict of interest.
Examples of Sovereign Credit Ratings
Standard & Poor's gives a BBB- or higher rating to countries it considers investment grade; below this (BB+ or lower), S&P deems them to be of speculative or "junk" grade. In 2019, for example, Zambia was given a B- grade, while Abu Dhabi, UAE received a AA. Fitch has a similar system. Moody’s considers a Baa3 or higher rating to be of investment grade, while a rating of Ba1 and below is non-investment grade. In 2019, for example, Bulgaria received a Baa2 rating, while Belgium was given a rating of Aa3. The ratings services explain their methodology on their websites.
In addition to their letter-grade ratings, all three of these agencies also provide a one-word assessment of each country's economic outlook at that point in time: positive, negative, or stable.