Posted in Finance Articles, Total Reads: 4232
, Published on 06 August 2011
Just when things were looking good post 2008 worldwide recession, we heard yet another news which was capable of pulling us back to the dark days of 2008. For the first time since 1917, Standard and Poor has downgraded the rating of USA from AAA to AA+. With the speculation of yet another round of recession in US, this news could result in mayhem in the stock markets across the world in the coming weeks. So what exactly are the implications of such a move and whether we are really heading for another round of recession. The experts have for long speculating of a double dip recession for months and this move could just be a signal for that.
What is exactly is a credit rating and why is it such important? Credit ratings determine whether a country / company will be able to meet its obligations. So before investing an investor on the basis of such rating will be in a position to take an informed decision on whether the investing company / country will be able to service its debt obligations. There are three top credit rating agencies which are held in high regard in the investment world. They are: Moody’s, Standard and Poor’s and Fitch IBCA. Each of these companies will provide an independent assessment which details the credit worthiness of a company / country and this credit rating will help the investor to determine how risky it is to invest money in a certain country / company.
The ratings which are given out by these companies fall between a certain band depending on the risk associated with investment.
Highest Credit Quality and Lowest Credit Risk
AA / A
High Credit Quality and Low Credit Risk
Good Credit Quality and Medium Credit Risk
BA / B / CCC / CC / C
Junk Credit Quality and Highest Credit Risk
Junk Credit Quality and Default
Agreed that credit rating makes sense because the investor invests in a company. But do the rating agencies give out rating for country’s as well. The reason being this rating actually provides a view on the country’s overall ability to provide a secure investment environment. The rating for a country takes in account the foreign currency reserves of a country, FDI of a country, how stable the country is politically as well as economically. So rating of a country is equally important as that of a company because institutional investors will consider the rating before getting money to invest in that country. So there a country with credit rating is more likely to get FDI / Institutional investment than a one without it. The rating actually assuages the fear of the investors who are investing in a country.
However in case of US downgrade the picture is still not clear as the other two rating agencies have not downgraded the ratings. One impact would be felt on the treasury bills issued by the US government. The downgrade could drive away investors and hence the government will have to increase interest rates which would increase the borrowing rates. But then AA rating is again a good rating and is a safe investment bet still as evident from the last week data where the stock market crashed but did not have major impact on the debt instrument issued by the US government.
But in this era of globalization the downgrade would surely cause ripples across the globe. With tight coupling among the various economies there would be some impact on the stock markets across the globe with investors pulling out investments from various markets. In India the impact would be in the form of strengthening of rupee which would impact the export oriented sectors. The vicious circle has the capability of engulfing a lot of other countries as well so it is the best interest of the entire world that US does not go into another round of recession. But then time has come for the strengthening of other economies so that the entire world is not too dependent on one such SUPER ECONOMY.
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