The Importance of Credit Rating Agencies

On December 20, 2022, Fitch Ratings maintained India’s rating at ‘BBB’ with a stable outlook.

What does BBB stand for?

  • A ‘BBB’ rating indicates that default risk expectations are currently low.
  • The ability to meet financial obligations is deemed adequate, but adverse business or economic conditions are more likely to impair this ability.

What is a Rating Agency?

  • Rating agencies evaluate an equity, debt, or country’s creditworthiness or potential.
  • Investors read their reports to make an informed decision about whether or not to invest in a specific country or companies in that geography.
  • They determine whether a country, equity, or debt is financially stable and whether it is at risk of default.
  • In layman’s terms, these reports assist investors in determining whether or not they will receive a return on their investment.

What do they do?

  • After new developments, geopolitical events, or a significant economic announcement by the concerned entity, the agencies re-evaluate previously assigned ratings on a regular basis.
  • Their reports are sold and distributed through financial and daily newspapers.

Grading pattern

  • The three major rating agencies, Standard & Poor’s, Moody’s, and Fitch, follow largely similar grading patterns.
  • Standard & Poor’s assigns the highest grade, AAA, to countries, equity or debt, that have an extremely high capacity to meet their financial commitments.
  • Its grading slab consists of letters A, B, and C, with a single or double letter denoting a higher grade.
  • Moody’s divides ratings into two categories: short-term and long-term. Its long-term grading scale is Aaa to C, with Aaa being the highest.
  • Fitch also assigns ratings ranging from AAA to D, with D being the lowest. It follows the same hierarchy as Moody’s and Fitch.

Criticism of rating agencies

  • To lend credibility to their inferences, popular rating agencies publicly reveal their methodology, which is based on macroeconomic data made publicly available by a country.
  • Credit rating agencies, on the other hand, have come under fire for allegedly causing the United States’ financial crisis, which began in 2017.
  • The rating agencies underestimated the credit risk associated with structured credit products and did not respond quickly enough to deteriorating market conditions.
  • They were charged with multiple counts of methodological errors and conflict of interest.

Do countries pay attention to ratings agencies?

  • A country’s rating downgrade has the potential to cause panic selling or offloading of investment by a foreign investor.
  • The European Union decided to regulate the agencies in 2013.
  • Overreliance on credit ratings may reduce incentives for investors to develop their own credit risk assessment capabilities.
  • Rating agencies in the EU are now only allowed to issue ratings for a country three times per year, and only after the close of trade in the entire Union.
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