What is a Rating Agency?

• A rating agency is a company that assesses the financial strength of companies and government entities, especially their ability to meet principal and interest payments on their debts.
• The rating shows an agency’s level of confidence that the borrower will honor its debt obligations as agreed. Each agency uses unique letter-based scores to indicate if a debt has a low or high default risk and the financial stability of its issuer.
• The debt issuers may be sovereign nations, local and state governments, special purpose institutions, companies, or non-profit organizations.

How ratings affect the market?

• At the corporate level, companies planning to issue a security must find a rating agency to rate their debt. Rating agencies such as Moody’s, Standards and Poor’s, and Fitch perform the rating service for a fee. Investors rely on the ratings to decide on whether to buy or not to buy a company’s securities.
• At the country level, investors rely on the ratings given by the credit rating agencies to make investment decisions. Many countries sell their securities in the international market, and a good credit rating can help them access high-value investors. A favorable rating may also attract other forms of investments like foreign direct investments to a country.
• A rating downgrade means that bonds issued by the governments are now “riskier” than before. Lower risk is better because it allows governments and companies of that country to raise debts at a lower rate of interest.

Why in News?

• Moody’s Investors Service (“Moody’s”), a leading rating agency, has downgraded the Government of India’s foreign-currency and local-currency long-term issuer ratings to “Baa3” from “Baa2”. It stated that the outlook remained “negative”.

What is the reason for this downgrade?

• There are four main reasons why Moody’s has taken the decision.
  • Weak implementation of economic reforms since 2017
  • Relatively low economic growth over a sustained period
  • A significant deterioration in the fiscal position of governments (central and state)
  • And the rising stress in India’s financial sector
• In November last year, Moody’s changed the outlook on India’s Baa2 rating to “negative” from “stable” precisely because these risks were increasing.
• Since many of the apprehensions that it had in November 2019 have come through, Moody’s has downgraded the rating to “Baa3” from “Baa2”, while maintaining the negative outlook.

What does “negative” outlook mean?

• The negative outlook reflects dominant, mutually-reinforcing, downside risks from deeper stresses in the economy and financial system that could lead to a more severe and prolonged erosion in fiscal strength than Moody’s current projects.
• In other words, a “negative” implies India could be rated down further.