Credit Ratings For All!

by: Otaviano Canuto

Debt and credit ratings remain all the time on your screen, right? But for a moment, forget about their impact in the U.S., Europe and emerging markets, where an abundant set of economic data exists both for international investors and bondholders. Instead, think of what would happen if you lived in one of the almost sixty developing countries that remain unrated by Standard & Poor's, Moody's and Fitch, the three international credit rating agencies. You would have very limited access to capital and investment, and the cost of borrowing would be significantly higher.

Let me explain why. In the case of countries not routinely tracked by the majority of investors, the absence of information on creditworthiness -- which is costly to acquire -- is a disincentive for bond purchases. Sovereign ratings act as widely available and internationally comparable indicators of a country's fiscal performance, collectively economizing on costs of information collecting and processing. Even if a government is not issuing bonds, the rating often fulfills a function as a "ceiling" for the private sector and its absence can negatively affect access to the international capital market. In addition, assessments of sovereign creditworthiness are also taken into account by donors providing official development aid.

So if your country is one of those developing countries still not rated by the three international agencies, your economy remains pretty much cut off from the many potential bond holders. This is unfair because an unrated country is not necessarily at the bottom of credit worthiness. Contrary to popular perception, some of the non-rated countries would even deserve to be considered investment grade, as two colleagues and I have illustrated in a World Bank work - Shadow Sovereign Ratings.

According to that study, many unrated countries turn out to be doing quite well. Of the 47 unrated countries analyzed, 7 countries are likely to be above investment grade (BBB- through AAA). Another 10 are likely to be in the BB category, equivalent to speculative grade; and 10 in the CCC or lower categories of high and very high default risk.

This shadow rating model is no substitute for the broader, deeper analysis that experienced rating agencies are expected to provide, but it gives us an approximate idea of where countries stand and what they need to do to improve.

There are numerous reasons for a country's reluctance or inability to be "officially" rated -- from the complexity of the process itself to some politician's fear of losing control over the final outcome. To overcome these disincentives, the international community should play an important role in helping developing countries obtain ratings and even get upgraded. The benefits totally outweigh the risks.

In the meantime, the next time you equate unrated with unworthy, please think twice.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.