Article Detail

The Changing Role of Sovereign Credit Ratings

Journal 36: Global Finance and Regulation

Simon Strong

Credit rating agencies (CRAs) are best known for publishing credit ratings for corporate issuers and corporate bonds. However, they also publish credit ratings for so-called sovereign issuers, which are typically national governments and central banks. Like corporate credit ratings, sovereign ratings are intended to provide a measure of a sovereign issuer’s willingness and ability to repay its debts in full and on time. The emphasis for a sovereign issuer is more on willingness than ability, since a sovereign entity is not exposed to legal sanctions if it defaults on its liabilities. A government can always, in theory, choose to service debt denominated in its domestic currency by increasing its money supply. However, the political and economic impact of this strategy can be so high that a government may choose to default on its debt even though it has the theoretical ability to repay it. In addition, there are extreme situations such as civil war or a military coup when a new government may choose to repudiate debts incurred by a previous administration.

The sovereign ratings that feature in financial headlines are those issued by Standard & Poors, Moody’s, and Fitch, known collectively as the “big three”. In the 1920s Poor’s Publishing (a predecessor of Standard & Poors) started issuing credit ratings for bonds denominated in U.S. dollars but issued by other national governments, known as “Yankee bonds”. After the Second World War Standard & Poors and Moody’s extended their rating of individual bond issues to rating national governments as issuers, although until the 1980s only the most developed economies were rated. In 1985, for example, Moody’s rated 14 sovereign issuers, and the majority of these received Moody’s top “Aaa” rating [Cantor et al. (2008)]. During the 1990s both the number and diversity of sovereign issuers receiving ratings increased steadily. By 2007, Moody’s was rating 107 sovereign issuers, and only around 20% of these received an “Aaa” rating [Cantor et al. (2008)]. A similar pattern of growth in the volume of sovereign ratings from all CRAs was driven by the increasingly global nature of their business and the need to provide a sovereign benchmark for corporate issuers in a wide range of locations around the world.