What is a Sovereign Credit Rating

A sovereign credit rating is the credit rating of a country or sovereign entity. Sovereign credit ratings give investors insight into the level of risk associated with investing in a particular country, including its political risk. At the request of the country, a credit rating agency will evaluate the country's economic and political environment to determine a representative credit rating. Obtaining a good sovereign credit rating is usually essential for developing countries in order to access funding in international bond markets.

BREAKING DOWN Sovereign Credit Rating

Another common reason for obtaining sovereign credit ratings, other than issuing bonds in external debt markets, is to attract foreign direct investment. To give investors confidence in investing in their country, many countries seek ratings from the largest credit rating agencies like Standard and Poors, Moody's, and Fitch. A solid rating from one of these agencies can provide further transparency and demonstrate a country’s good standing. Smaller but still effective rating agencies include DBRS, China Chengxin, Dagong, and JCR. Subdivisions of countries may also issue sovereign bonds, which require rating; however, many major agencies exclude smaller areas, such as country regions, provinces, and municipalities.

Examples of Sovereign Credit Ratings

Standard and Poors gives a BBB- or higher rating for sovereign bonds they consider investment grade; below this (BB+ or lower), S&P deems the security speculative or ‘junk’ grade. In 2016, for example, Zambia was given a B grade (negative), while Abu Dhabi, UAE received a AA (stable). Fitch has a similar system and results. Moody’s considers investment grade bonds to be rated a Baa3 or higher, in their system. Those bonds, rated Ba1 and below are non-investment grade. In 2016, the Congo received Baa2 (non-investment grade), while Belgium was given AA3 (stable).

Sovereign Credit Ratings and Sovereign Credit Risk

Sovereign credit risk is related to its sovereign credit rating in that the risk portion highlights the potential for a government to become unwilling or unable to meet its debt obligations. Key factors that many investors look for when deciding how risky it might be to invest in a specific country or region include: its debt service ratio, growth in domestic money supply, its import ratio, and the variance of its export revenue, among other factors.

During the Great Recession in 2008 many countries – most notably, Greece – faced growing sovereign credit risk sovereign risk, stirring global discussions about bailing out entire nations if they were not able to repay their debts.