Assessing the risk of investment with Sovereign Credit Rating

There are many metrics that we can use to consider macroeconomics. The sovereign credit rating of Moody’s, Fitch, and Standard & Poor’s is one parameter with a unique methodology. 

Bank Indonesia Senior Economist, Firman Darwis said that this rating reflects the country’s or entity’s financial capacity and default risk. “The sovereign rating is more concerned with assessing the risk of investment, both direct and indirect. Pointing it toward investments in the form of assets resembling factories. If not explicitly related, it is all about public or private debt,” said Firman, (6/4/2021).

Since sovereign credit ratings tend to be short-term in nature, every observer agency often updates its rating on a regular basis. This ranking can also be adjusted as a result of unforeseen circumstances. This is dependent on certain factors, which normally necessitate special handling and have a significant impact on a country’s conditions. 

Ratings are projected to rise from time to time as a supporter of investment decisions. However, for the time being, the ranking, which serves as a proxy for each nation, is intended to be constant. 

“This ranking reflects our country’s struggle to provide a favorable investment environment for both domestic and foreign investors. This rating attempts to persuade investors to withdraw funds when they are needed,” said the man who had worked at Ernst & Young as an Assurance and Business Advisory.

The rating levels produced by these independent agencies have rigorous methodologies that are quantitatively and qualitatively assessed. There are elements that are considered in rating level, such as institutional and government efficiency, as measured by the licensing and corruption indices. Besides, the economic score is based on GDP, a country’s trade resilience, economic diversity, and uncertainty.

External score, which includes currency, foreign exchange reserves, and external debt is also considered. This is due to the government’s willingness to support the private sector in meeting financial stability requirements while avoiding disruptions to the domestic market.

A fiscal ranking is based on fiscal efficiency and an estimate of debt burdens at maturity. The monetary score of the exchange rate system, monetary effectiveness, and inflation rate, each of which has its own implications for each country.

Furthermore, Firman noted that today’s rating agencies take peer-group considerations and country outlook into account in their assessments to make them more comprehensive. 

So, what makes a sovereign credit rating relevant for investors to monitor? According to Firman, there are three major advantages to using this indicator. The first is price discovery, the higher the ranking, the higher the market price of a financial instrument. This is accompanied by the number of interest rates that investors will obtain. The better a financial instrument is on the market, the lower the yield that the issuer can get. 

Moreover, the sovereign credit rating serves as a benchmark or upper limit for corporate bond ratings sold outside of the country. Bond ratings are rarely lower than those of their country of origin since this is a function of bonds issued abroad. 

Finally, there is the market predictor, where ratings in the age of knowledge disclosure are to promote the spirit of customer security and investor comparison of financial instruments. Since it has given comparative information, an issuer may be identified as a business that applies the principles of transparency and reliability through the disclosure of information from an entity.

Finally, Firman emphasized the significance of the knowledge dimension, which is widely disseminated throughout the culture. “We must learn together, and when interpreting facets of the news, we must do so in a fair manner. We must be able to read all measures scientifically, rather than just the amount of debt that exists. Since several factors can affect a country’s financial performance and political stability, understanding the economy broadly is important,” said Firman. 

Have you reviewed your portfolio using all of the available details, including your sovereign credit rating?

Written by Student Reporter (Erwin Josua, EMBA 2021)

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