Analysis Of Country Rating By Major Rating Agencies And Its Implications

Find rating and analysis of the country of your origin or the country where you currently reside provided by one of the major rating agencies (Moody, Standard & Poor's, or Fitch Group) and answer the following questions:

1) Identify and critically appraise how the rating agency makes connections between the overall debt level of your country, external debt, inflation, institutional resistance and other macroeconomic factors, and the overall rating.

2) Critically appraise how the rating issued by the rating agency of your choice translates into the bond yields. Examine recent bond yields of your country and countries with comparable ratings.

3) Critically access who the investors in your country’s bonds are and what role the bonds play in their portfolios.

Factors Considered by Rating Agencies for Determining Country Ratings

1.The rating agency mainly uses different levels of debt, external debt, inflation and macro-economic factors for determining the overall rating of a country. The sovereign credit rating is used by the agencies for detecting the countries current rating, which is determined by utilising their current per capital income, GDP growth, Inflation, external debt, and defaulting history. These factors directly help rating agency to determine the credit rating position of the country, which allows the investors to detecting the risk and return that will be generated from the investment. Taningco (2018) mentioned that investors rely on the credit rating agency for determining the risk and return attributes of a particular investment, which eventually help in improving their income generation capability.

There are specific measures that are used by the credit agency for determining the rating of the country. These measures and factors are depicted as follows.

The analysis of per Capita Income of the country is mainly evaluated by the credit rating agency for determining the level of income that is accumulated by the Kuwait government, which helps in repaying their debts. In addition, the high per capita income will ensure that government will generate high level of income from taxes, which will be used for repaying the debt. The detection of per capita income also allows the credit rating agency to determine the political stability of the country, which can help in determining the capability of the country to support their debt payments (Chen et al. 2014).

The GDP growth rate of the country is also evaluated by the credit rating agency for detecting the income growth position of the government. In addition, from the evaluation it can be detected that high GDP growth makes the country’s existing debt easier to be paid by the government. The rising GDP growth rate reduces the level of concern for the lenders, as it increases the chance of debt payment by the government due to the rising GDP, which can improve the level of income from tax collection. Hence, from the high growth rate the increment in tax collection is possible by the Kuwait government, which also improves the fiscal balance of the country.

The inflation rate is considered the third factor, which needs to be evaluated by the credit rating agency, as it helps them to improve the level of income from operations. Inflation helps in signalling the problems that is associated with the country’s finances, while it also indicates the political instability of the country. This relevantly depicts the level of problems that is hindering the country’s ability to support their debt obligations.

Translating Country Ratings into Bond Yields

The analysis of the external debt position of the country would eventually help in detecting the current position of the government in repaying their debts. This detection process allows the credit rating agency pinpoint the specific condition of the country and determines their credit rating conditions. The defaulting history of the country is also evaluated by the credit rating agency for detecting whether the country will not pay their debt obligations in future. The countries with defaulting background will have lower credit rating indicating the high risk involved in the investment (Shi and Sun 2015).

The oil revenue of Kuwait is also considered in in the credit rating of the government bonds, as it ensure the continued income of the quasi-government. The oil price has been fluctuating in recent years, which is affecting the income generation capability of oil producing countries. However, stability in the oil price is seen between the ranges of $45 to $55, which would allow the Kuwait government to generate high level of revenue from oil sale. The oil barrels produced by Kuwait and changing oil prices are accommodated in valuing the credit rating of the country.

Therefore, with the identified factors the credit rating companies are mainly able to determine the adequate credit rating of country and determine the risk and return associated with the government bonds. The credit rating agencies such as Moody’s, Standard & Poor’s, and Fitch Ratings relevantly utilise the same factor for determining the countries current rating position, which allows the investors to make adequate investment decisions. Yu (2018) argued that credit rating agency wrongly rated the mortgage bonds before the financial crisis, which depicts the low reliability on their rating positions.

2.

Figure 1: Rating value of Moody’s, Standard & Poor’s, and Fitch Ratings

(Source: Countryeconomy.com 2018)

The above figure directly depicts the level of rating, which is used by Moody’s, Standard & Poor’s, and Fitch Ratings for determining the credit rating of a particular investment option. In addition, the rating agency relevantly helps in determining the level of bonds yields, as higher rating bonds will produce low yield, while the lower rated bonds give higher yield from investment. The concept of the bond yield is directly related to the risk level of investors, as higher risk obtained by the investors in their investment would directly have negative impact on performance of the organisation. In addition, the information presented in the above figure directly indicates that until low medium grade bond the credit rating will have low yield, whereas declining credit rating will increase risk and yield of the financial instrument. Therefore, investors with the help of credit rating are able to translate the ratings into yields of the financial instrument.

Country	Moody's ratings	S&P ratings	Fitch ratings
Kuwait	Aa2	AA	AA
United States	Aaa	AA+	AAA
United Kingdom	Aa2	AA	AA
China	A1	A+	A+
Hong Kong	Aa2	AA+	AA+
Qatar	Aa3	AA-	AA-

Role of a Country's Bonds in Investors' Portfolios

The table directly depicts the overall credit rating of difference countries by the three major credit rating agencies. The table indicates that the credit rating of Kuwait is mainly comparable with the listed countries, which indicates the positive attributes of the government bonds. The constant income that is generated from the oil produce of Kuwait is also considered in evaluating the overall credit rating of the country. In addition, the rating directly indicates that the rating position of Kuwait is mainly at the levels of United Kingdom, which is considered to be one the major developed nations in the world. The investment grade of Kuwait is mainly at low position, as the rating is within the confinements of Aaa to Baa3 for Moody’s, AAA to BBB- for S&P and AAA to BBB- for Fitch (Cbk.gov.kw 2018). This directly indicates that the credit rating of Kuwait in at par with developed nations, where the risk and yields are low.

3.There are several investors interested in Government Bonds, as it provides them with a stable income and security for their investments. The Government Bonds are relatively considered one of the major investment options foreign investors who are keen on reducing the level of risk involved in investment. Moreover, investors to minimize the risk from the portfolio and maximize the level of income that could be generated from investment use some of the bond. Kuwait has an adequate Credit rating where it provides low risk and low yield Bonds to the investors. Therefore, conservative investors and hedge fund managers are relatively the major buyers of the bond that is being produced by Kuwait (Becker and Ivashina 2015). Multinational companies, Kuwait banks, Kuwait domestic investors, International investors, hedge fund managers, and Low risk investors rely on Government board, which have high credit rating.

The Government Bonds relative you play a major role in the portfolio of the identified investors, which are depicted as follows.

Government bonds are considered to be one of the financial instruments that allow investors to reduce their portfolio risk and maintain adequate returns from investment. The government Bond relatively reduces the risk of the total portfolio that has been formulated by the investor with high risky assets. government Bond are considered to be risk free assets, which allow the investors to minimize the level of risk involved in investment and maximize the income that could be generated from a Portfolio. Bonds are also considered an adequate diversification measure, which allows the investors to secure and diversify their Investments.

Government Bonds are also used as an adequate hedging measure against the slowing down economics, which allows investors to accumulate the adequate returns that are required from their investment. Investors use the government Bond in their portfolio for adequately hedging their current position against any kind of slowdown in the financial market. This process directly allows investors to ensure the continuity of the returns that could be generated from an investment. However, the income that is generated from government bond is relatively low due to the high credit ratings (Chiang and Niehaus 2016).

The Government Bonds also ensure capital preservation of the investors as the investment will be realized after the completion of the bond. The bond market does not coordinate as the equity market, which can hamper the initial capital investment of the investors during the turmoil times. During the end of the maturity, the total invested amount of the Government Bonds is relatively provided to the investor regardless of the Economic conditions, which is not provided by any equity stocks (Harford and Uysal 2014).

The continuous income generation capability of the Government Bonds is a relatively seen in the form of coupon payments, which is provided by the bonds. However, the coupon rate of the bond is low, but the bonds ensure a continuous income for the investors.

References

Becker, B. and Ivashina, V., 2015. Reaching for yield in the bond market. The Journal of Finance, 70(5), pp.1863-1902.

Burger, J.D., Warnock, F.E. and Warnock, V.C., 2018. Currency matters: Analyzing international bond portfolios. Journal of International Economics, 114, pp.376-388.

Cbk.gov.kw. 2018. [online] Available at: https://www.cbk.gov.kw/en/images/S-and-P-Feb-2018---EN-10-125813-1.PDF [Accessed 20 Dec. 2018].

Cbk.gov.kw. 2018. [online] Available at: https://www.cbk.gov.kw/en/images/Moody-May-2017-Report-10-123636-2.pdf [Accessed 20 Dec. 2018].

Chen, Z., Lookman, A.A., Schürhoff, N. and Seppi, D.J., 2014. Rating-based investment practices and bond market segmentation. The Review of Asset Pricing Studies, 4(2), pp.162-205.

Chiang, C.C. and Niehaus, G., 2016. Investment herding by life insurers and its impact on bond prices. University of South Carolina working paper.

Countryeconomy.com. 2018. Rating: Kuwait Credit Rating 2018. [online] countryeconomy.com. Available at: https://countryeconomy.com/ratings/kuwait [Accessed 20 Dec. 2018].

Harford, J. and Uysal, V.B., 2014. Bond market access and investment. Journal of Financial Economics, 112(2), pp.147-163.

Shi, G. and Sun, J., 2015. Corporate bond covenants and social responsibility investment. Journal of business ethics, 131(2), pp.285-303.

Taningco, A., 2018. ASEAN Bond Market Integration: What Drives Cross-Border Bond Investment in ASEAN?. DLSU Business & Economics Review, 27(2).

Tradingeconomics.com. 2018. Credit Rating - Countries - List . [online] Available at: https://tradingeconomics.com/country-list/rating [Accessed 20 Dec. 2018].

Yu, B.K., 2018. Analysis of Changes in Determinants of Foreigners¡ Ç Bond Investment before and after the Global Financial Crisis: The Case of Korea (in Korean) (No. 2018-18).