Sovereign credit rating is the rating of a sovereign entity that estimates the future ability and willingness of the sovereign government to service its financial obligations in full and on time. According to S&P, sovereign, is “a state that administers its own government and is not subject to or dependent on another sovereign for all or most prerogatives.” Sovereign credit ratings focus on the risk associated with a sovereign government’s non-payment of debt obligations...

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RATING INDICATORS

Rating agencies look into many factors to decide sovereign credit ratings. Both quantitative and qualitative parameters are evaluated. Quantitative factors, namely, GDP growth, per capita income, inflation, fiscal balance, external balance, external debt, economic development, and default history play an important role in the ratings . CRAs also assess ‘qualitative factors’ such as political stability (level of political risk, risk of fundamental regime change, military conflict, geopolitical risks, political system’s ability to address economic and fiscal challenges, and willingness to pay), growth outlook,..

RATING SCALES

Rating agencies use different alphabetical combinations of lowercase and uppercase letters, with plus or minus signs or numbers added to further explain the long-term and short-term credit rating. These symbols indicate the different levels of rating and credit worthiness of nations. For instance, S&P uses uppercase letters and the plus or minus sign while Moody's uses lowercase and uppercase letters with numbers...

SOVEREIGN RATING METHODOLOGY

When a sovereign or its representative requests the CRA to rate its security, the rating is termed “solicited” whereas when there is no agreement with the sovereign, it is considered “unsolicited”. Sovereigns are generally rated on an unsolicited basis when the CRA believes there is significant market interest in them. The CRA provides the pertinent information regarding the rating process to the sovereign issuer..

SIGNIFICANCE OF CREDIT RATINGS

Credit ratings are based on diverse information that aims to reduce the information asymmetry between issuers and investors and thereby assist investors to make sound investment decisions based on credit quality. Most importantly, the ratings are “not facts, but opinions” of qualified financial experts to evaluate creditworthiness. It was the growing number of defaults in the payment of interest and repayment of the principal borrowed over the years that made credit ratings necessary...

ISSUES AND CONTROVERSIES SURROUNDING CREDIT RATINGS

Considering the critical role played by CRAs in the contemporary financial architecture, policymakers and researchers have observed some shortcomings of the rating agencies. First, the sovereign credit rating agency market has been described as an oligopoly market. The three big agencies – Moody’s, S&P, and Fitch –control the vast majority of the market. In such markets, investors value comparable and consistent ratings from a well-known CRA and issuers build a trust with one or two CRAs. As stated by Y-Xu (2011) “Dearth of competition usually leads to deterioration in products and services and breeds corruption within an industry” ...

SNAPSHOT OF UNITED KINGDOM (UK) (2014-2017)

The UK is a prominent trading power and financial center. It has a highly advanced capitalist economy which has slowed down since the referendum vote to leave the European Union (EU) in June 2016. A depreciation of the British pound has raised consumer and producer prices but experts say, “UK economy has been resilient in the two years since the June 2016 Brexit vote and did not ‘fall off the cliff’ as many feared.” ..

SNAPSHOT OF UNITED STATES (US) (2014-2017)

The US is the issuer of the world’s prominent reserve currency which gives it an uncommon and exceptional financing flexibility. The US Treasury market is the most liquid asset market in the world supported by its large, rich, and diverse economy. Its institutional strength and extensive growth policies offset the government’s high level of debt. (Refer to Table 5 for the economic data of US.)..

BUILD A RATING MODEL

BUILD A RATING MODEL Using the 5 parameters and their constituent variables (Refer to Table 6), build a model and assess the credit scores of the US and the UK. The following steps can be followed..

EXHIBITS

Exhibit I: Preparing and using Credit Rating Model