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.

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.

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.

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.

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.

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.