Nepal’s first credit rating: A historic event

It is natural to wonder how accurate credit rating agencies like Fitch and Moody’s are in assessing countries. Nepal’s situation has been shown to be good in the first-ever sovereign rating in Nepal.

Rating agency

Fitch Ratings, one of the world’s three major rating companies, has given Nepal a ‘Double B Minus’ rating, which is said to be the best among South Asian countries except India. Fitch has given this rating based on Nepal’s excellent foreign exchange reserves and strong economic growth projections. The government can influence the operation and financial environment of corporate entities existing in the country.

The basic economics and trade dynamics that develop within a country are influenced by other unique features such as infrastructure, roads, ports and telecommunications, etc. 

Parameters and factors

So, to analyze the various controls that the government can use that can affect the business performance of each company within the government's jurisdiction, it is considered: regulatory framework, tariffs, fiscal policy, monetary policy, foreign exchange controls, physical and human infrastructure, financial markets, macro factors (consumer spending, inflation, interest rates, foreign exchange risks).

While giving ratings, they usually look at the socio-economic situation and other factors such as political stability, inflation rate, power index, spending on welfare schemes, current account and fiscal account deficit, balance of payments position and GDP growth, etc.

While rating banks and financial institutions, they look at the internal strength of the institution, various financial parameters, and growth rate. 2/3 years of performance, current market scenario and the prevailing economic situation in the country of the said financial institution(s).

Process

The ‘rating’ is carefully checked by experts and issued after discussion by the committee. The only limitation is that these analyses are based on published figures, sometimes combined with anonymous data provided by the issuer. 

If the data provider feeds analysts with incorrect data,  there is little they can do.

In retrospect, the Enron case in the United States and the Parmalat case in Italy are good examples of ratings based on fraudulent data. 

Of course, there are external auditors (paid by the issuers) who verify the accounts and many supervisors who have little, if any, upfront role. That being the case, one can trust the rating agencies, although the published ratings and related research are only one of the data to be taken into account. The others are published accounts, related audits, and economic forecasts.

Accuracy

Generally, ratings are accurate unless fraudulent data is provided. 

Some people and their critics say that even international rating agencies are not saints. Sometimes it has been shown that there were reasons other than professional ones on the day of the assessment (grade down or upgradation) and they tend to base their decisions on perceptions and political views and without any concrete reasons and hard facts. But such cases are rare.

​On average, Nepal’s current rating is two places below India, but is the best among other South Asian countries. It should be considered historic to get such a position in the first-ever rating.

Sovereign credit

A team from Fitch Credit Ratings came to Nepal a few months back  to assess Nepal’s sovereign credit rating. This grade was obtained on the basis of an analysis of Nepal’s short-term stability in the economy.

​A sovereign rating provides information about the risks that may arise when investing in a country’s bonds, including political risks. ​At the request of a country, the credit rating agency independently evaluates the economic and political environment of that country and provides it with a rating. Also, foreign investors look at the ‘country rating’ of that country to assess how safe it is to invest in a country.

​Although the rating received by Nepal now generally recognizes Nepal’s ability to repay its debt, it has shown signs of economic risk. ​A country needs a credit rating to raise debt by issuing bonds in the international market.

Foreign investment

Countries also give ratings to attract foreign investment. The world’s largest S&P, Fitch and Moody’s use ratings ranging from the best ‘AAA’ (triple A) to the worst C grade.

​The way they assign ratings varies slightly. For example, Moody’s gives a C rating to the worst, that is, a bankrupt country or entity, while S&P gives an SD rating and Fitch gives an RD-D rating.

​Among them, ratings from BBB minus and above are considered good for investment, while ratings below that up to B minus are considered speculative ratings. ​Ratings below that are considered high-risk or likely to go bankrupt. Fitch gave this rating after studying Nepal’s weak revenue situation, political instability, and the need for reform in the economic structure.

Fitch has positively assessed some of Nepal’s economic indicators. Low debt burden is considered a good thing.

What is Fitch Ratings?

​Fitch Ratings is a company that rates the integrity of debt instruments such as bonds based on the financial stability of the issuing company or government entity. The role of Fitch Ratings is to determine the likelihood that the issuing entity will default and fail to repay its debt.

Fitch Ratings, Moody’s and Standard & Poor’s are the three major agencies that rate bonds. Using similar grading systems, the companies scale bonds from high-quality ‘investment grade’ to low-quality ‘speculative’ or junk bonds.

Bonds are rated before they are issued, and that process plays a large role in the return that must be paid to investors. The higher the risk, the higher the return that must be paid. Events later in the life of the bond can also cause the agencies to change the bond’s rating.

Fitch also provides sovereign credit ratings that describe each nation’s ability to meet its debt obligations. Sovereign credit ratings help investors gain insight into the level of risk associated with investing in a particular country. ​

Countries invite Fitch and other credit rating agencies to assign representative ratings to assess their economic and political environment and financial conditions.

A good credit rating is essential, especially for developing nations, as it gives them access to international bond markets.

In 2018, Fitch gave the United States its highest long-term sovereign credit rating, AAA. At the bottom was Brazil with BB-.

​Nepal’s government debt is 44 percent of gross domestic product (GDP). 

Fitch pointed out that the high level of debt at low interest rates, and a large portion of Nepal’s external debt at concessional rates, has protected the country from fiscal pressures. The report also noted that foreign exchange reserves are good.

Overreliance on remittances is also cited as a long-term problem. It also pointed out that Nepal needs to improve in some areas to improve its rating. Fitch also suggested that political stability should be accompanied by long-term economic policy. Fitch noted that Nepal’s economic stability has improved.

Many European politicians have long held the view that they are biased against European countries, or biased in favor of large corporations that pay them, or biased in some other twisted fashion.

​In Sept 2011, after S&P downgraded Italy, Silvio Berlusconi is remembered for threatening the rating agencies, accusing them of ‘political motivation’. This may have something to do with the fact that all the big three firms are American, although Fitch says it has a ‘dual’ headquarters structure—New York and London (and has argued in the past that its ultimate owners are French).

Accusations that they were to blame for the 2008 global financial crisis were also widespread.

In the Asian context, credit rating agencies have also been blamed for the 1997-8 financial crisis.

The subjectivity involved in the exercise of judgment by rating analysts when factoring in rating decisions regarding the qualitative, ambiguous, institutional quality, political economy, ‘willingness to pay’ and governance have been shown empirically to be important. For some critics, the door to bias may, in this way, be clearly framed.

Overall, Nepal’s first-ever ‘credit rating’ is a source of pride, self-respect and a good start for the country. It is about addressing its shortcomings and weaknesses, rather than highlighting its negative aspects and failures in other countries. In the coming days, the country can expect progressive development through its successful use.