Grading a Country
We could say that the graders of sovereign debt use a “rubric” to decide whether a country has a high or a low score. In the classroom, students are given rubrics which specifically describe how a test is graded. A rubric is a list of facts and ideas that compose a high grade or a low one.
When NPR’s Planet Money visited Standard & Poor’s to find out their “rubric”, they described a two step process. First S & P checks a variety of topics that include the country’s debt, monetary policy, exports, imports, budget, and election results. They look at objective and subjective data, even including what the media is saying. Next, all information is given to a 5 person committee that decides what the rating should be.
Recently, The Guardian described what the three major ratings agencies, Standard & Poor’s, Fitch, and Moody’s, do and listed the grades of nations ranging from Albania (B+) to Vietnam (BB). The grades are based on how likely a nation is to pay back its debt fully and on time. Because the United States and Canada, for example, are considered very likely to pay back all that they borrow, they received the highest rating: AAA. The lowest grade is a CCC and maybe even an R.
Controversial during the subprime crisis, the ratings agencies generate criticism for their sovereign debt ratings also. Bill Gross, a prominent bond investor and the co-founder of PIMCO, questions how Spain, “a country with 20% unemployment… that has defaulted 13 times during the past two centuries” can have AA and AAA ratings.
The Economic Lesson
When countries borrow, they most typically issue bonds. Bonds are IOUs that pay interest in exchange for money from the lender for a specific period of time. A lender can be a person, a business, or another country. A country’s loans can be called sovereign debt.