What is a credit rating and what are its benefits

On March 13, 2015, the credit rating agency Standard & Poor's confirmed Bosnia and Herzegovina's sovereign credit rating „B with stable outlook".

Based on the decisions of the Council of Ministers, Bosnia and Herzegovina signed contracts for the preparation and monitoring of the sovereign credit rating of Bosnia and Herzegovina with two international rating agencies, Moody's Investors Service and Standard & Poors. The signatory on behalf of Bosnia and Herzegovina is the Ministry of Finance and Treasury of Bosnia and Herzegovina. The Central Bank of Bosnia and Herzegovina (CBBiH), as the fiscal agent of the Ministry of Finance and Treasury of Bosnia and Herzegovina, coordinates the preparation and monitoring of the sovereign credit rating of Bosnia and Herzegovina.

As a result of its analyses, on March 13, 2015, the credit rating agency Standard & Poor's confirmed Bosnia and Herzegovina's sovereign credit rating „B with stable outlook". In July 2012, the agency Moody's Investors Service confirmed Bosnia and Herzegovina's sovereign credit rating „B3" and changed the outlook „from watch - negative to stable outlook“.

What is a country's credit rating?

In short, a country's credit rating is an assessment of the ability and willingness of a country's government to service its debt, on time and in full. First, it should be said that the rating measures the ability of the state to repay its debt. Second, it is important to note that the definition mentions two words: ability and willingness to pay the debt. Namely, the risk assessment takes into account economic factors, assessing the ability to repay the debt, but also political factors in the country, i.e., assessing the willingness to repay the debt. They are usually related, but not identical. Third, the definition shows that the debt must be repaid in full and on time.

How to interpret the rating?

The professional public is aware that it is common to assign letter grades for the creditworthiness of a country. The more letters from the beginning of the alphabet, the better the rating. However, it should be said that there is not just one rating grade for a country. Some companies actually give two grades. There is a distinction between the government's rating for repaying debt denominated in its own currency and debt denominated in foreign currency. Letter grades in each category (foreign and domestic currency) range from AAA, which is considered the highest rating, to SD grade, which indicates that the debt is not being repaid (from English Selective Default). In other words, a AAA grade indicates the lowest probability that the debt will not be repaid, i.e., it indicates the best debtor. A grade of a single letter A indicates a low probability that the debt will not be repaid, but such a country's sensitivity to changes in circumstances is greater than that of a country with a triple A grade.

A BBB grade indicates a good debtor, a low probability of problems, but changes in circumstances could jeopardize debt repayment. This grade is also considered the lowest so-called investment grade rating. This means that a country with this grade can independently appear on the international capital market as an issuer of bonds, i.e., that it can borrow from foreign banks under “normal”, not speculative conditions. It should be said that there are examples of countries with a lower grade successfully issuing bonds.

Grades of BB and lower (B, CCC, etc.) indicate so-called speculative credit ratings for a country. For example, a grade of just C means that problems with debt repayment are very likely. SD is the designation for non-repayment of debt.

To enable more precise ranking of countries, the letter grades are often supplemented with a “+” or ”-“ sign. Naturally, an A+ grade is a higher rating than a plain A, just as BBB- is a slightly weaker grade than BBB.

Along with the letter grade, an opinion is usually given on expectations of how that grade will move in the future. Thus, there are stable outlooks (no changes expected), positive outlooks (grade changes for the better expected) or negative outlooks (changes to a worse rating expected in the foreseeable future).

What benefits does a country have from a rating?

The benefits of a country's credit rating are multiple. Here are some:

Every country that wants to independently borrow on the international capital market, i.e., issue bonds, or borrow as a state from commercial banks in the world, needs to have a credit rating. As in the rest of finance, the more favorable the rating, the better the debtor the country is. This, in turn, means that it will be able to borrow more favorably on the market, i.e., at a lower interest rate, a larger loan amount, or a longer repayment period. Thus, a country with an AAA grade can borrow significantly more favorably than a country with a BBB grade, while a country with a B grade practically cannot independently borrow on the international capital market, or can do so under speculative conditions, with very high interest rates. Of course, lower interest rates on borrowed funds mean lower debt repayment amounts, which is more favorable for any country. And reasonable borrowing means that a country can develop not only from its own resources but also from those of others, which, assuming healthy investments of borrowed funds, means faster economic growth, and thus greater prosperity for the country as a whole.

By publishing its credit rating, a state increases information about itself. Therefore, every country that strives to attract foreign direct investment increases transparency with an obtained credit rating. All potential investors and creditors are always pleased to have as much information as possible about a country. Of course, each of them must do their “homework” and analyze a particular country, but an internationally comparable rating from a globally recognized agency certainly speeds up the decision-making process.

One of the main features of modern economic trends is the growth of transparency. Today, all countries publish incomparably more data about themselves than was the case twenty years ago. By publishing a rating, a country clearly states that it has nothing to hide and that all data is public. Even when the rating is unfavorable, it should be publicly announced.

The rating itself is an additional test of a country's overall economic policies. A wise person will always gladly listen to an evaluation of their work. Therefore, sovereign states should not ignore the opinion of others about their overall policies, or more precisely, the expert assessment of the ability to service public debt in the future. This gives the country one of the criteria for comparison with other countries. Such a comparison is based on facts, not on prejudices that often exist.

The process of obtaining a credit rating is complex and requires a lot of knowledge that cannot be read in books. The agencies that perform the rating set high requirements regarding data on the country's economy, regarding assessments and forecasts for the future. This forces the country to approach the analysis of its debt repayment capabilities with great seriousness, which is not always the case. Therefore, it is better to enter this process as early as possible.

It should be said that besides country ratings, it is very common in the world for companies to have ratings. The credit rating of each company largely depends on the credit rating of the state. Usually, a company's rating cannot be higher than the state's, but in some exceptional cases, this is possible.

What does a country's rating depend on?

Companies engaged in credit rating assessment take into account a number of quantitative and qualitative indicators about a country. Thus, the main groups of indicators are: political risk, income and economic structure, economic growth potential, fiscal system adjustment capacity, total consolidated state debt, various other liabilities (e.g., non-financial state-owned enterprises), monetary stability, external liquidity, public sector debt burden and private sector debt burden. It is important to say that there is no single methodology, i.e., unique weights by which a series of different indicators is converted into a single grade, but this summarization depends on the overall impression of the analysts, i.e., the persons who make the final decision.

How does the process of obtaining a credit rating proceed?

To obtain a credit rating, a country's government (usually in cooperation with the central bank) signs a contract with one of the agencies engaged in this business. The process of assigning a credit rating itself can take months. First, the agency asks the country for a whole series of indicators, economic and political. Consistent series of quality economic variables for at least five years are often requested, and justification of forecasts for the future (short and medium term) is required. After analyzing the data, representatives of the agency visit the country where they hold extensive talks with all relevant authorities in the country.

It should be said that full cooperation of all levels of government with the agency is very important. Only in the case of availability of all data and full cooperation of all participants can an adequate picture of the country and thus an appropriate rating be obtained.

After obtaining the initial rating, representatives of the company usually visit the country again at least once a year. In the meantime, the country is obliged to regularly submit the requested data to the agency, and the agencies also use all other available data to regularly monitor possible changes in the situation in the country.

What are the main agencies that do credit ratings in the world?

Today, there are a number of companies that deal with ratings of both states and companies. However, the three most prominent and largest companies are certainly two American ones, Standard and Poor’s (abbreviated S&P) and Moody’s, and the European FitchIBCA. More developed countries usually have ratings from all three companies, but for a country starting the process of obtaining a rating, choosing one of the most reputable

(Central Bank of Bosnia and Herzegovina)