Alroy Commentary - What are sovereign ratings and the determinants of credit ratings?
Over last few years, sovereign ratings play an important role in the financial markets. For example, Standard and Poor, one of the credit rating companies, downgraded the rating of the U.S. in 2011, triggered more than 20 percent correction in the equity markets. What are sovereign ratings and what are the determinants of credit ratings?
Like other credit ratings, sovereign ratings calculated the probability of a borrower will default on its obligations. Governments would like to obtain credit ratings to access the international capital markets. Many investors would like to invest in securities with credit rating over those without. Without a clear description of determinants of credit ratings from the raters, investors believed the factors included –
Per capita income and GDP Growth – Higher income and potential income, the greater the ability of a government to repay debt.
Inflation – High inflation may imply structural problems in the government’s finances.
Fiscal balance and External balance – A large fiscal and current account deficit indicates a country relies on borrowing and funds from abroad heavily. Those deficits will become unsustainable if persist for a long time.
Default history – A country with default history is likely to perceive with higher credit risk.
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