When a country or other sovereign entity receives a sovereign credit rating, it is viewed as having higher creditworthiness than a private company or organization. Ratings assigned to a country's sovereign debt can inform investors about the nature and extent of the political risk they face by purchasing that country's debt.

Credit rating agencies examine a country's economic and political climate and provide a rating at the country's request. To access bond markets abroad, emerging nations must first improve their sovereign credit ratings.

Learning About Government Credit Ratings

Countries often seek a sovereign credit rating for reasons other than issuing bonds in external debt markets, such as to entice foreign direct investment (FDI). Many nations seek credit ratings from the world's top agencies to boost investor confidence. The three most influential rating agencies are Standard & Poor's, Moody's, and Fitch.

Other prominent rating organizations include the Japan Credit Rating Agency, the DBRS, and the China Chengxin International Credit Rating Company (JCR). Occasionally, subnational entities within countries will issue their sovereign bonds, which must also be rated.

Rankings of Eurozone Member States' Sovereign Debt

Many European countries' credit ratings were lowered because of the European financial crisis, and Greece defaulted on its debt as a direct result of the crisis. Several independent European countries abandoned their respective currencies in favor of the Euro. Their national currency is no longer used to denominate their sovereign debts.

To prevent defaults, countries in the Eurozone cannot have their national central banks "print money." While the Euro did lead to increased trade between members, it also increased the likelihood of default among members and lowered many sovereign credit ratings.

Credit Rating Factors for Nations

Credit rating organizations use qualitative and quantitative factors when evaluating a country's sovereign creditworthiness. The elements that account for the variation in credit ratings provided by the various rating agencies were laid out in detail by Richard Cantor and Frank Packer in their 1996 work "Determinants and Impacts of Sovereign Credit Ratings." To name a few of the contributing factors:

Average Annual Income

The term "per capita income" is used to approximate the average yearly salary of a population. To determine the per capita income, divide the total annual income of all residents of a particular area by the total number of residents in that area. A more extensive tax base means more money coming into the government, which means spending more on things like infrastructure and paying off debt.

An Increase In The Country's Gross Domestic Product

A country's GDP growth rate is the annualized percentage increase in GDP from one quarter to the next as the economy moves through a business cycle. Because more GDP equals more money in the government's coffers to pay off debt, a country with a strong economy is more likely to be able to keep up with its payments. If the growth rate is negative, it indicates that the economy is contracting and that the government may be unable to meet its debt obligations if the current trend continues.

Inflation Rate

An increase in inflation will affect a country's ability to service its debt, which is why the inflation rate is closely monitored. As the populace grows increasingly unsatisfied with the rising cost of living, a country's government may become unstable due to the high inflation rate.

External Debt

Some nations' economic and infrastructure initiatives are funded almost entirely by external indebtedness. A higher risk of default means less willingness among international lenders to provide financing, which can be a problem if debt levels continue to rise. Suppose a country's total debt denominated in foreign currency is more than its total income denominated in foreign currency from exports. In that case, that country will face an increasing amount of pressure.

Learn To Trade And Invest

Interested in expanding your knowledge of the financial markets? There are more than enough courses to get you started, regardless of your preferred study method. Udemy is an online learning platform where you can take classes from industry professionals and view them for free whenever and wherever you like. You'll be able to learn the ropes of option spreads, day trading, and more. Learn more about Udemy now and sign up for courses straight now.

Sovereign Credit Rating Example

Countries with a rating of BBB- or higher from Standard & Poor's are considered investment grade, while those with a rating of BB+ or worse are considered speculative or "junk." While Chile's rating remained A+, S&P awarded Argentina a CCC- in 2019. Even Fitch uses a system like this. Moody defines "investment grade" as a Baa3 or higher rating, whereas a "Baa1" or below rating is considered "speculative." In 2019, Moody's gave Greece a B1 rating and Italy a Baa3 rating.