It seems everyone is talking about South Africa’s credit rating and the implications a possible downgrade by ratings agencies will have for the country. Counting Coins decided to have a closer look at these Big Brothers and why they are putting us under a microscope.
What are credit rating agencies?
If you want to apply for a loan at a bank, the bank will use your credit score to determine whether or not you qualify for a loan -as well as the amount you qualify for. A credit score is a score determined by credit bureaux, and informs credit providers how much debt you can afford and how likely you are to pay it back.
Just like credit bureaux determine a credit score for individuals, credit rating agencies determine the creditworthiness of countries, governments or very large companies by giving these a credit rating.
Who are these credit rating agencies?
The most important and largest rating agencies in the world are:
• Moody’s Investors Service
• Standard & Poor’s
• Fitch Ratings
These rating agencies look at a number of factors to determine the ability and willingness of a country to repay its debt.
There are some differences in the methods each one of these three rating agencies use to evaluate the creditworthiness of a country.
The company rates borrowers on a scale from AAA to D – AAA (high grade) being the best rating, and D (in default) being the worst. In some cases, the agencies also speculate whether or not the country has a negative or positive outlook. The outlook tells us whether the rating of a country is likely to improve or get worse.
What do credit rating agencies look at when they rate countries?
There are a number of factors that might influence the rating given to a country. Some of the most important aspects incude the economic growth of a country, political stability, any changes that might influence a specific industry in a country, the state of large institutions within the country – like banks, and the general financial wellbeing of the government.
Why do credit ratings matter?
Imagine you have some money that you would like to invest in a country. Before doing so you would like to have some form of guarantee that you will make a profit on your investment. Although there can never be a 100% guarantee that you will make a profit – or even get your money back – you will be able to use credit ratings to see what state a country is in before investing your money there.
If a country has a low credit rating or a “junk status”, you will probably think twice before investing your money there.
Probably the most important reason why countries should care about their rating is the fact that it directly influences their ability to borrow money and make debt. The better its rating, the easier it is for a country to borrow money from international markets like the World Bank.
Since credit ratings indicate how likely the borrower is to repay its loans, the lender will use these to determine how much interest they should ask when lending money.
Similar to when you make debt, the lower the credit score (credit rating), the higher the risk, and thus the higher the interest rate. This results in the country becoming more indebted – and the more indebted the country becomes, the harder it becomes for future generations to repay all the debt.