A major ratings agency has downgraded Greek debt to junk status, further damaging the country’s efforts to avoid default and raising doubt over the overall health of the euro. France 24 explains how credit rating agencies work and why they matter.
Greek debt is currently worth “junk”, the major ratings agency Standard and Poor’s told investors on Tuesday. The agency also downgraded Portugal’s rating to A-. The financial slur marked the first time a eurozone member lost investment-grade rating since the currency’s 1999 debut.
Greece cried foul at the downgrade, saying the S&P’s move did not correspond with
Source : Standard & Poor's (as of 28 April 2010)
The Netherlands: AAA
Spain: AA Ireland: AA Italy: A+ Portugal: A- Greece: BB+ *
*Greece is the first EU member to be downgraded to a speculative grade rating since the euro was introduced in 1999.
the real data. But few investors were listening to Athens. A dip in market confidence led European and then Asian stocks to plunge Tuesday and Wednesday and sent the euro to one-year lows against the dollar.
While Portuguese bonds are still investment grade, some market observers think a junk rating will soon infect Portugal.
“Contagion will spread to Portugal, to Spain and to other countries and may lead to a second dip in the world recession,” warned Ali Fatemi, a professor at the American Graduate School of Business and Economy in Paris.
While a rating expresses one opinion about the quality of a credit issuer, the reaction to the Greek downgrade is evidence that ratings can have sweeping consequences for local and global economies. So who are these agencies and why do their opinions matter so much?
Making the grade
A credit rating agency, or CRA, is a company that gives its opinion about an institution’s ability to pay back loans.
The largest and most important CRA’s are the US-based companies Standard and Poor’s, Fitch and Moody’s, which are overseen by the Securities and Exchange Commission in their assignment of credit ratings.
The institutions they rate include corporations, local governments and states that issue debt-like securities, such as bonds.
The CRA’s assign credit ratings, based on tiers that are meant to reflect a company or government’s creditworthiness.
The junk rating refers to the BB+ rating by S&P. This is the highest speculative grade (the best of risky investments) in S&P’s letter-rating system.
The highest rating, AAA, reflects an “extremely strong capacity to meet financial commitments”, according to S&P, while the lowest D rating is issued for institutions that fail to pay their financial commitments.
Greece’s current BB+ grade is six notches below the AAA grade.
S&P’s downgrading of Greece and Portugal tells investors what they might expect if they are holding bonds issued by these counties.
A lower rating does not automatically trigger a sell-off of bonds, since investors look at many aspects of a company or country’s investment potential. And a high rating does not guarantee that a company or country it will not default on loans.
The US-dominated CRA’s have been criticized for making high ratings based on the willingness to incorporate US ideas of best business practices and for the lack of transparency in their ratings.
But countries can do little to curb their power. Downgrades have the inevitable effect of making potential bond buyers put away their wallets or for bond owners to trade them.
This effect is a significant blow to a country like Greece, which will face added pressure from the EU and IMF to balance its budget as a condition for receiving a critical financial aid package.