For a layman like me, Credit Rating Agencies are like policemen controlling the economic thoroughfares of the world’s nations and assessing the creditworthiness of individuals.
Credit ratings are predominantly provided by three main “independent” rating agencies: Standard & Poor’s (S&P), Moody’s Investor Services (MIS), and Fitch IBCA Ratings (Fitch). There are also many others that provide ratings for individuals, such as Experian and Equifax.
A credit rating is an independent assessment of the creditworthiness of a government, a company, or an individual in general terms or with respect to a particular debt or financial obligation. Credit ratings differ from credit scores, which are assigned to individuals.
In the case of Sri Lanka or Pakistan?
Several months ago, when Sri Lanka and/or Pakistan were downgraded by the Credit Rating Agency Fitch, the whole world noticed, and there were concerns that it could be disastrous for the people and the economy.
Recently, the same agency, Fitch, has targeted and downgraded the world’s largest economy, the United States of America. Fitch is defending its controversial decision, citing the US debt mountain as a major concern. According to Fitch, American debt makes up 113% of GDP, and there are fears that this growing debt will adversely affect economic output, which they find pretty alarming. However, it’s worth noting that the US has not raised Federal Reserve rates to curb inflation. The US government has criticized Fitch’s decision as bizarre, arbitrary, and based on outdated data.
Fitch, on the other hand, maintains that the challenges facing the US include addressing long-term issues, such as Social Security and Medicare problems, which may require politically unpopular moves leading up to the Presidential Election in 2024.
Coincidentally, Fitch’s decision came amidst President Donald Trump’s indictment in Court on August 2, 2023, implying that Trump’s tax cuts while he was President might have impacted revenues, leading President Biden to implement “excessive spending initiatives” to balance the situation, as needed.
Ripples of action abroad
There is also apprehension about the possible downgrading of France’s credit rating, which could have a catastrophic impact on the Eurozone and its efforts to safeguard the Single European Currency.
The European Stability Mechanism (ESM), based in Luxembourg and established in 2012, was designed to provide instant access to financial assistance for member states of the Eurozone in the event of emergencies. The ESM acts as a backstop for the Euro.
On June 2, 2023, Standard & Poor’s Global Rating downgraded France’s rating from “AA” to “AA.”
Unlike a Third World country or any Sovereign nation, if a Eurozone member state is unable to pay its debts as they fall due, it cannot instruct its Central Bank to issue more currency. Instead, a member state of the Eurozone has to issue new debt, which is bought by the ESM, and the proceeds are used to pay the pre-existing debt.
Thus, the European Stability Mechanism’s credit rating remains at AAA. Some of its members, like Germany and the Netherlands, generally maintain a very high credit rating, presumably due to the belief that Europe’s Banking Sector, comprising several nations, could withstand a severe economic downturn without depleting its financial buffer against losses.
Should small nations form organizations similar to the ESM to maintain a consistently high credit rating and avoid falling into debt traps? Is this one reason why Sri Lanka hopes to tie in with the Indian Rupee? Your guess is as good as mine.