VIІI  Международная научно-практическая конференция

«Перспективные вопросы мировой науки – 2012»

Экономические науки/4.Инвестиционная деятельность и фондовые рынки

Post graduate student Mogylko L.V.

Kyiv National Taras Shevchenko University, Ukraine

Sovereign credit rating as an indicator of country's investment attractiveness

In modern terms for entering the international capital market for state as issuer it is necessary to obtain international credit and investment evaluation of their debt, because the presence of an issuer rating has a higher probability to attract the necessary resources. The higher the rating the state receives the lower cost of borrowed funds. But sovereign credit rating is not only an indicator of risk debt, but is also the criterion of investment attractiveness and solvency of the country. Solvency of the state and its credit rating is an indicator of confidence by certain creditors to the state, determining the level of sovereign risk.

Studies of sovereign credit ratings assignment are devoted work of many scientists, especially such as: L. Andrianova, V. Bazilevich, S. Borinets, N. Gaillard, M. Elkhoury, E. Lyubkina, J. Mirkin, V. Lisovenko, B. Rubtsov, L. Fedulova and others.

Sovereign credit ratings it is an assessment the feasibility and willingness of government, each rated countries, pay the debt in accordance with the conditions of their release. The sovereign rating is an assessment of credit risks of national governments and do not reflect the default risk of other issuers. Ratings of private issuers may be on the same level as the top national government, and may be lower, rarely exceeding the ratings of private issuer sovereign rating. Top national government is in some way, a guide by which the rankings are determined by all other issuers that operate within its jurisdiction.

Sovereign credit ratings give investors insight into the level of risk associated with investing in a particular country and also include political risks. At the request of the country, a credit rating agency will evaluate the country's economic and political environment to determine a representative credit rating. Obtaining a good sovereign credit rating is usually essential for developing countries in order to access funding in international bond markets. Another common reason for obtaining sovereign credit ratings, other than issuing bonds in external debt markets, is to attract foreign direct investment. To give investors confidence in investing in their country, many countries seek ratings from international credit rating agencies (CRAs) to provide financial transparency and demonstrate their credit standing.

A credit rating compresses a large variety of information that needs to be known about the creditworthiness of the issuer of bonds and certain other financial instruments. The CRAs thus contribute to solving principal agent problems by helping lenders "pierce the fog of asymmetric information that surrounds lending relationships and help borrowers emerge from that same fog". So, credit rating agencies play a key role in financial markets by helping to reduce the informative asymmetry between lenders and investors, on one side, and issuers on the other side, about the creditworthiness of companies or countries [2].

CRAs stress that their ratings constitute opinions. They are not a recommendation to buy, sell or hold a security and do not address the suitability of an investment for an investor. Ratings have an impact on issuers via various regulatory schemes by determining the conditions and the costs under which they access debt markets. Regulators have outsourced to CRAs much of the responsibility for assessing debt risk. For investors, ratings are a screening tool that influences the composition of their portfolios as well as their investment decisions.

Most well-known international CRAs that assigned sovereign credit ratings are «Moody’s Investors Service, Inc.», «Standard and Poor’s Corporation», «Fitch Ratings Ltd.» and «Rating & Investment Information Inc.». There are also wide differences in their methodologies and definitions of the default risk, which renders comparison between them difficult.

However, the sovereign credit rating by rating agencies developed a specific rating scale. To indicate the levels of the rating agencies used by literary system – letters of the alphabet from A to D. The values of credit ratings from different agencies are presented in table 1.

Таблиця 1

Comparative value of most well-known international CRAs* [3]

Total value of ratings	Moody's	S&P	Fitch	R&I
High ability to meet financial obligations.	Ааа	ААА	ААА	ААА
	Аа	АА	АА	АА
	А	А	А	А
Sufficient capacity to meet financial obligations, but a higher sensitivity to adverse economic conditions.	Ваа	ВВВ	ВВВ	ВВВ
	Ва	ВВ	ВВ	ВВ
	В	В	В	В
A dangerous situation. Fulfillment of obligations or fully dependent on favorable business, financial and economic conditions. Maybe declared bankruptcy, but the performance of financial obligations is made.	Саа	ССС	ССС	ССС
	Са	СС	СС	СС
	С	С	С	С
Default on financial obligations.		SD	DDD
		D	DD
			D

*The ratings may be added digital signs "+/-" or modification (1, 2, 3) to demonstrate the relative position within the main category.

As we can see from table 1, based on the credit rating scale laid qualitative assessments of the "higher quality", "good quality", "above-average quality," etc. Each rating category reflects the level of possible delays in payments. In terms of thresholds of credit risk within the character of the scale, each rating category refers to one of the classes of securities, which are three: the investment, speculative and outsider.

The investment group includes securities whose issuers have a strong position on the board on its obligations – the rating of AAA (Aaa) to BBB (Baa). The reliability of these bonds is provided by large assets and high rate of return sufficient to pay the interest. Bonds in this class are recommended for investment of savings banks, insurance companies, pension funds, investment funds.

Non-investment grade, which includes speculative and outsider securities (group BB/Ba, B and CCC/Caa/D), for which was fixed in the international practice known as "junk bonds», literally "trash" for these bonds characterized by uncertainty with respect to interest payments of principal and stability of, their value is subject to significant fluctuations depending on the economic situation. Potential investors in these securities are institutions that are not responsible for the depositors' funds. Outsider group means that the issuer is on the verge of bankruptcy or bankrupt. Category C bonds are often assigned to newly established companies, with respect to the stability or survival of which there are doubts. This rating is more a warning of possible losses, as a recommendation to invest. The lower the rating on the stairs is the borrower, the more he must pay extra for benchmarking the return of the obligations and the more the price of one division of the rating scale. With the growth of overall economic instability, these so-called «quality spreads» or yield spreads usually increase [1].

The CRAs determine sovereign ratings based on a range of quantitative and qualitative factors with which they gauge a country’s ability and willingness to repay

it’s debt. The limited number of actual sovereign defaults constrains back-testing of any empirical model when trying to determine a sovereign’s creditworthiness (and associated probability of default). Another factor that differentiates the rating of sovereigns over and above other instrument ratings is the concept of “willingness to pay”. This reflects the potential risk that even if the sovereign had the capacity to pay, it may not be willing to pay if it judges the social or political costs to be too great. To capture this element, CRAs assess a range of qualitative factors such as institutional strength, political stability, fiscal and monetary flexibility, and economic vitality. In addition, a country’s track record of honoring its debt is an important indicator of willingness to pay, a characteristic that is otherwise difficult to measure objectively.

These qualitative factors are complemented with quantitative factors such as the level of debt and official international reserves, the composition of debt (in particular the currency composition and maturity profile), and the extent of the debt burden, for example as captured in interest costs [4].

The fundamental analysis that feeds the rating process is comparable across the CRAs, but it differs in the way individual factors are classified and grouped, and in the specificity with which the CRAs present their methodologies. Hence, although the overall information sets are similar, Fitch and Moody’s classify their indicators by four categories of key factors, while S&P uses nine (table 2).

Table 2

Key Factors in Sovereign Credit Rating Assessments [4]

CRAs	Factors
Fitch	Macroeconomic policies, performance, and prospects; structural features of the economy; public finances; external finances.
Moody’s	Economic strength; institutional strength; financial strength of the government; susceptibility to event risk.
Standard & Poor’s	Political risk; economic structure; economic growth prospects; fiscal flexibility; general government debt burden; offshore and contingent liabilities; monetary flexibility; external liquidity; external debt burden.

In the whole, in assessing sovereign risk, CRAs highlight several risk parameters of varying importance: economic; political; fiscal and monetary flexibility; and the debt burden.

Economic risk addresses the ability to repay its obligations on time and is a function of both quantitative and qualitative factors. Economic risk is assessed by such indicators as: prosperity, diversity and degree to which economy is market-oriented; income disparities; effectiveness of financial sector in intermediating funs availability of credit; robustness of financial sector; competitiveness and profitability of non-financial private sector; efficiency of public sector; protectionism and other non-market influences; labour flexibility, size and composition of savings and investment; and rate and pattern of economic growth.

Political risk addresses the sovereign's willingness to repay debt. Political risk includes such indicators as: stability and legitimacy of political institutions; popular participation in political processes; orderliness of leadership successions; public security; transparency in economic policy decisions; and geopolitical risk.

Fiscal and monetary flexibility includes such indicators as: general government revenue, expenditure, and surplus/deficit trends; revenue-raising flexibility and efficiency; expenditure effectiveness and pressures; timeliness, coverage and transparency in reporting; pension obligations; price behaviour in economic cycles; money and credit expansion; compatibility of exchange rate regime and monetary goals; institutional factors such as central bank independence; range and efficiency of monetary goals; impact of fiscal and monetary policies on external accounts; structure of the current account; composition of capital flows; and reserve adequacy.

Debt burden assessed by such indicators as: general government gross and net (of assets) debt as a per cent of GDP; share of revenue devoted to interest; currency composition and maturity profile; and depth and breadth of local capital markets; gross and net external debt, including deposits and structured debt; maturity profile, currency composition, and sensitivity to interest rate changes; access to concessional lending; and debt service burden [2].

Willingness to pay is a qualitative issue that distinguishes sovereigns from most other types of issuers. Partly because creditors have only limited legal redress, a government can (and sometimes does) default selectively on its obligations, even when it possesses the financial capacity for debt service. In practice, political risk and economic risk are related. A government that is unwilling to repay debt is usually pursuing economic policies that weaken its ability to do so. Willingness to pay, therefore, encompasses the range of economic and political factors influencing government policy.

So, the logic underlying the existence of CRAs is to solve the problem of the informative asymmetry between lenders and borrowers regarding the creditworthiness of the latter. Issuers with lower credit ratings pay higher interest rates embodying larger risk premiums than higher rated issuers. Moreover, ratings determine the eligibility of debt and other financial instruments for the portfolios of certain institutional investors due to national regulations that restrict investment in speculative-grade bonds. That’s why for countries are very important of getting a high credit rating that will ensure growth of their investment appeal and will attract financial resources on more favorable conditions for them.

References (Literature)

1. Andrianova L.N. Securities rating: basic theory and practice: Diss...candidate of economic sciences: 08.00.10 / L.N. Andrianova / Finance Academy under the RF Government. – Moscow, 2002. – 184 p.

2. Credit rating agencies and their potential impact on developing countries by Marwan Elkhoury // United nations conference on trade and development, Discussion papers, No. 186 January 2008, p. 33. [Electronic resource] – Available: http://www.unctad.org/en/docs/osgdp20081_en.pdf.

3. Gaillard Norbert A Century of Sovereign Ratings [Hardcover] / Norbert Gaillard. – 2011, X, 196 p. [Electronic resource] – Available: http://www.springerlink.com/ content/978-1-4614-0523-8#section=960099&page=7&locus=36.

4. The uses and abuses of sovereign credit ratings // Chapter 3 of Global financial stability report: Sovereigns, funding, and systemic liquidity, International Monetary Fond, October 2010, p. 38. [Electronic resource] – Available: http://www.imf.org/external/pubs/ft/gfsr/2010/02/pdf/chap3.pdf.