Sovereign Rating is a tool that helps the investors decide before investing in a country.
A country’s financial health is determined by its past/present policies,economic indices and its global economic might.
Risks are indicated and it helps the investors.
AAAis the best rating for any country. On this scale, the ratings go down to AA+, AA, AA-, A+ and so on till the worst rating which is D, which means the government is in default. Downgrading on the scale means that the risk in investment in that country’s debt is assessed to have increased and because of this, existing investors might withdraw their money while future ones might prefer to invest in safer venues.
How often have national governments defaulted on their debt?
As a national government controls most of its affairs, in the case of default, it can’t in practice be forced to pay back its debts. Some part of its overseas assets might get seized and political pressure may be applied on it, but all of that gives little relief to the investors. The government also faces pressure from domestic investors. Governments rarely default. Typically, a government on the verge of a default enters into negotiations with the investors to try and reschedule the debt or roll them over.
The market is driven by sentiments and in many cases, suspicious investors demand higher returns. There have been many incidents of sovereign debt crisis in the past. Recently, Greece, Ireland and Portugal were swallowed up by a crisis when the governments were unable to pay back investors. Similarly, in the early 1980s, Latin American countries were caught in a debt crisis as the foreign investments grew higher than their incomes and the governments were unable to pay back. Similar situations have also occurred in Mexico, Russia and Argentina.
How is rating scale devised?
The most important element in devising the scale is an analysis of the history of sovereign defaults. According to S&P, most of the defaults since the 19th century have occurred because of past policies which keep a government ill-prepared for sudden events like war, regime change or changes in trade patterns. There are essentially five key factors in determining the government’s rating.
These factors are Institutional effectiveness and political risk; economic structure and growth prospects; external liquidity and international investment position; fiscal flexibility and performance combined with debt burden; and monetary flexibility.
While some of these can be measured quantitatively, others are more qualitative in nature and hence the agency has devised scales to quantify them. For instance, political stability is rated on the basis of effectiveness, stability, and predictability of the sovereign’s policy-making, transparency of political institutions and so on.
United States of America Long-Term Rating Lowered To 'AA+' On Political Risks And Rising Debt Burden; Outlook Negative Overview • We have lowered our long-term sovereign credit rating on the United States of America to 'AA+' from 'AAA' and affirmed the 'A-1+' short-term rating. • We have also removed both the short- and long-term ratings from CreditWatch negative. • The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics. • More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011. • Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon. • The outlook on the long-term rating is negative. We could lower the long-term rating to 'AA' within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case http://www.standardandpoors.com/servlet/BlobServer?blobheadername3=MDT-Type&blobcol=urldata&blobtable=MungoBlobs&blobheadervalue2=inline%3B+filename%3DUS_Downgraded_AA%2B.pdf&blobheadername2=Content-Disposition&blobheadervalue1=application%2Fpdf&blobkey=id&blobheadername1=content-type&blobwhere=1243942957443&blobheadervalue3=UTF-8