Credit ratings – why they matter for the global goals

Did you know that much like report cards for students, countries too have “grades” associated with them? One type of these “grades”, called credit ratings, affect countries’ cost of borrowing money. The ratings are given by just a handful of private companies, known as credit rating agencies (CRAs). To gain more insights on this topic, we talked to Shari Spiegel in UN DESA’s Financing for Sustainable Development Office (FSDO).

Ms. Spiegel’s team in UN DESA recently launched three new publications (DESA Policy Brief, FSDO Policy Paper and a DESA Working Paper), which explore the relationship of credit rating agencies to the debt challenges of governments and sustainable development progress. They introduce proposals to improve sovereign ratings to better support countries’ progress on the Sustainable Development Goals (SDGs).

Can you explain what the credit rating agencies (CRAs) are? Should we be concerned about their role in relation to the sovereign debt issues?

“Yes, absolutely. Credit rating agencies are private companies that evaluate the credit worthiness of borrowers, including countries. They provide information to investors to help them assess countries’ risks. Much like report cards for students, credit rating agencies assign letter grades to both countries and corporations that issue debt. Ratings between AAA (the highest rating) and BBB- are considered “investment grade”, or roughly meaning low to moderate risks. Ratings between BB+ and D (the lowest rating) are commonly referred to as “speculative grade”, meaning higher risks. Countries with lower ratings are considered to have a higher probability of defaulting on their sovereign debt, and generally face higher borrowing costs. We should remember that ratings are based on a range of factors that impact a country’s risk of default and thus how expensive it is for the country to borrow.”

With the COVID-19 pandemic and the downturn of the global economy, many countries saw increasing debt levels. How has this affected countries and how have their “ratings” been impacted? Can you break it down for us?

“The pandemic worsened countries’ economic outlook. Many countries are now facing challenges to mobilize financial resources to respond to the pandemic and achieve the SDGs, while meeting their debt obligations. This has led credit ratings agencies to downgrade the ratings of many developing countries. Since some investors are not allowed by their rules to lend to “speculative grade” or high-risk countries, these downgrades can lead to what we call “cliff-effects.” This means a large-scale sell-off of risky assets, such as developing country government bonds, when the issuer is downgraded to below investment grade status.

In 2020, credit rating agencies disproportionately downgraded the ratings of developing countries, despite their having seen smaller contractions of their economies compared to developed countries. This could be due to a number of factors, such as greater vulnerabilities of these countries, but the appearance of bias by credit rating agencies against developing countries hurts both the ratings industry and developing countries. Fear of ratings downgrades also impeded some countries from participating in official debt relief programs, such as the G20’s Debt Service Suspension Initiative (DSSI) – even though these would strengthen a country’s ability to repay its debt.”

And beyond the pandemic, are there other challenges from credit ratings for countries?

“Beyond the COVID-19 pandemic, credit rating agencies also have challenges in incorporating long-term risk factors such as climate risks in their ratings. The rating agencies have been doing more to incorporate risks from climate change in their assessments, but the relatively short time horizon for ratings, makes it difficult to appropriately reflect countries’ long-term investments in resiliency and productive growth. These are all crucial factors to consider a country’s path to sustainable development and achieving the SDGs.”

How can countries avoid falling off the “cliff” and ensure that credit ratings are more consistent with long-term development goals?

“Here, I would raise four proposals to address these challenges. First, ratings agencies should be more transparent about their decision-making process, so that there would be less appearance of bias. For example, either the rating agencies, or a public entity, could model-based sovereign ratings for all countries, enabling investors to use this as a benchmark to help better distinguish between model-based inputs and value-added judgement inherent in sovereign credit ratings. Second, credit-rating agencies could develop long-term ratings, which incorporate positive effects of SDG investment. The use of scenarios for both economic and non-economic risks could make long-term assessments more manageable to produce. Third, credit rating agencies should increase dialogue with the public sector to gain a deeper understanding of government policies, including international official programs and initiatives related to debt sustainability. Fourth, investors, regulators, and rating agencies should work together to avoid cliff effects and rapid sell-offs of assets, by taking a more graduated approach to rating tiers, instead of the current split between investment grade and speculative grade categories. The UN DESA publications elaborate further on these proposals, so I welcome you all to read them!”

What about the role of the UN? How is UN DESA taking part in efforts?

“There are a variety of stakeholders involved on this issue, including users of credit ratings, the rating agencies, Governments, financial regulatory agencies, and multiple international bodies that work on financial regulation. One of the mandates of the United Nations is to improve coordination of the international economic and financial system, and we are working with partner institutions to discuss potential solutions.

UN DESA is also promoting new thinking on solutions on this issue. For example, in March we held a high-level meeting on the role of credit rating agencies, which can be watched online.

We will continue to engage with the rating agencies, investors, regulators and other actors to try to enhance developing countries abilities to borrow for investment in sustainable development.”

Learn more about UN DESA’s work in this area here.