By Rachel Croft

What is a sovereign credit rating and why is it important?

A sovereign credit rating is a country’s credit rating as determined by credit rating agencies at the request of that particular country. Credit rating agencies consider a number of factors when determining a country’s credit rating, including such country’s economic and political environment and any associated risks.

From an investor’s perspective, sovereign credit ratings are important as they give investors an insight into the economic and political risks associated with investing in a particular country. From a country’s perspective, particularly developing countries, it is often critical to obtain a good sovereign credit rating in order to attract foreign direct investment and funding in external debt markets.

Recent sovereign credit rating downgrades

2016 has been a record year for sovereign downgrades. So far in 2016, Fitch Ratings has downgraded 16 countries, S&P has downgraded 21 countries and Moody’s a total of 25. Countries downgraded by some or all major credit rating agencies so far this year include Kazakhstan, Mozambique and the United Kingdom. Although different events and circumstances impact on different countries, the three major rating agencies have attributed recent downgrades largely to lower commodity prices (in particular falling oil prices), a stronger US dollar and, for some countries, the decision of the United Kingdom in June this year to withdraw from the European Union.

Impact of a sovereign downgrade on project financing

It is difficult to identify or predict the precise impact of a sovereign credit rating downgrade on projects in a particular country given that a ratings downgrade often is tied with one or more geo-political events which may themselves have a direct or indirect impact on a project. The impact of a downgrade on the appetite of lenders to invest in a country also will be highly dependent on the credit rating that a particular country held to start with and the level of perceived fiscal distress that may be behind the downgrade; i.e., whether investors perceive that the country is running into an unsustainable debt situation or is facing a more transient issue, or whether an actual sovereign default has occurred. A downgrade from AAA/Aaa to AA+/Aa1, for example, is likely to have a less dramatic impact on a country’s ability to raise debt (or the associated cost) than a downgrade from BBB-/Baa3 to BB+/Ba1, which would push a country into the non-investment grade or “junk” category.

However, generally speaking, sponsors or developers seeking financing for a project in a country that has recently faced a credit rating downgrade should consider the key issues below.

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