S&P gives 19 countries its highest sovereign rating of AAA. The better the rating, the lower the investment risk
Slide Show >>On Sept. 19, Thai tanks rolled through the streets of Bangkok in a bloodless coup. The same day Standard & Poor's put the country's credit rating under review.
While credit ratings may not matter much to champions of democracy, foes of government corruption, or the Thai troops battling Muslim insurgents in the country's south, they can make a substantial difference to the
country's finances. If S&P lowers its ratings, it could hurt the Thai Finance Ministry's goal of strengthening the financial system to avoid a reprise of the country's fiscal crisis of 1997.
The reason is that just as average folks fret over their credit scores—which influence how much money banks will lend them and the interest rate charged—so do countries. When a country's sovereign credit rating is downgraded, it makes it that much more expensive for its government to borrow money.
Unlike private individuals, however, this information isn't provided by credit-score keepers Experian and Dun & Bradstreet (DNB), but by big rating agencies like Standard & Poor's, Moody's (MCO), and Fitch. The top tier of borrowers gets the agencies' coveted AAA rating. This means that the government has an extremely strong ability to pay its debt on time. "The higher the rating, the lower the perceived default risk and lower the premium it has to pay on its debt," says John Chambers, managing director of S&P Sovereign Ratings Group.
Credit trends have been positive over the last year, thanks to strong global growth, rising commodity prices, ample cross-border capital flows, and low real interest rates, Chambers says. In the emerging-markets area, for example, Standard & Poor's Rating Services upgraded eight countries, by a single notch, and downgraded one in the last 12 months through August. The most recent upgrades were Indonesia (to BB- on July 26) and China (to A on July 27). Earlier this year, S&P upgraded South American countries Venezuela (to BB- on Feb. 3), Brazil (to BB on Feb. 28), and Argentina (to B on Mar. 23). Hungary was the only downgrade (to BBB+ on June 15).
Fixed-income traders and fund managers use sovereign ratings mainly as a screening tool to find securities. Don Quigley, co-manager of the Julius Baer Total Return Bond Fund (BJBGX), says his fund can buy only investment-grade bonds, so he looks for issues with a sovereign rating of BBB or higher. For example, he says he won't buy the debt of Turkey because its rating is below investment grade, but the fund currently has positions in Australia, Iceland, New Zealand, and Mexico. "We'll be aware of what its rating is, but it's really where the country's yield curve is vs. the U.S.," Quigley says. "We use it as a screening tool, but it's not what I rely on most."
To come up with a sovereign rating, S&P—which, like BusinessWeek.com, is a division of The McGraw-Hill Cos.(MHP)—looks at political risk, income and economic structure, growth prospects, fiscal balances, debt stocks, contingent fiscal risks, monetary policy, and external liquidity and external debt (debt owed to foreign creditors), Chambers says. S&P's highest rating is AAA, and anything BB+ and below is speculative, or not investment grade. S&P says the rating is not a recommendation to purchase, sell, or hold a financial obligation issued by a government, as it does not comment on market price or suitability for a particular investor.
JAPAN NOT TOP-RATED.
Not every country has a sovereign rating, mainly because some governments don't ask for it. They also have to pay the agencies for a rating. At this point, only 19 out of 113 countries that S&P rates have its highest sovereign rating of AAA. (The U.S. State Dept. recognizes a total of 193 countries around the world.) They range from major countries in Europe and North America to smaller ones such as Liechtenstein. One economic power that doesn't have S&P's highest rating is Japan, which has been rated AA- since February, 2001, given S&P's view that the country has been slow to implement fiscal and structural reforms to cut spending and increase revenue.
Among the countries S&P rates, none is currently in default. If a country does default, S&P lowers its rating to SD, and the government's interest payments go up. S&P notes that Belize, which has a sovereign rating of CC-, has signaled that it intends to restructure its debt in the near future, which typically means that it will be in default.
Although current economic conditions are favorable, events can quickly change a country's credit worthiness, as during the Asian financial crisis that began in mid-1997. "We were taken by surprise, as were most others," Chambers says. "However, in retrospect, our ratings held up rather well." Of the 10 East Asian governments that were rated as of July 1, 1997, five remained unchanged for the next 18 months during the height of the crisis, and only two were downgraded out of investment grade (ratings of BB+ and below). One of the downgrades was Indonesia, which subsequently defaulted. (As mentioned earlier, the country is now rated BB-.) Says David Beers, Standard & Poor's managing director of sovereign and global head of international public finance ratings: "If we all knew for certain what the future holds, there would be no credit risk."
To see the 19 countries with S&P's AAA sovereign ratings, click here.