Standard & Poor has warned India that it could lose its investment grade credit rating in the coming months. So, should we pay heed, you might ask. The answer is yes, we do need a higher rating. Here's why:
What is an investment-grade credit rating?
Investment-grade ratings range between AAA (superior) and BBB- in S&P's nomenclature. India's rating, BBB-, is considered the lowest investment grade by market participants.
Any rating below BBB- is considered speculative grade. And CCC to C, the ratings below B, are considered vulnerable grade. The last category, D, is of bonds in default. Bonds that are not rated investment grade are known as highyield or junk bonds. Ratings from 'AA' to 'CCC' may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories.
Why is an investment-grade rating necessary?
Big financial institutions diversify their investment risks by not putting all their eggs in one basket. So they invest in equities and bonds throughout the world.
Some of these institutions are pension funds, trusts and endowments, all of which follow very regimented investment styles and thus put their money only in investment-grade instruments. Hence, they will immediately exit bonds of any country that loses its investment-grade rating.
What are the implications?
If a country loses its investment-grade rating, it would face much higher costs for its future borrowing as its credibility will not be considered high and fewer lenders would want to invest. This loss of confidence would result in an outflow of funds from the equity markets as well because then investors would begin to have doubts about the economy as a whole.
Investment-grade ratings range between AAA (superior) and BBB- in S&P's nomenclature. India's rating, BBB-, is considered the lowest investment grade by market participants.
Any rating below BBB- is considered speculative grade. And CCC to C, the ratings below B, are considered vulnerable grade. The last category, D, is of bonds in default. Bonds that are not rated investment grade are known as highyield or junk bonds. Ratings from 'AA' to 'CCC' may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories.
Why is an investment-grade rating necessary?
Big financial institutions diversify their investment risks by not putting all their eggs in one basket. So they invest in equities and bonds throughout the world.
Some of these institutions are pension funds, trusts and endowments, all of which follow very regimented investment styles and thus put their money only in investment-grade instruments. Hence, they will immediately exit bonds of any country that loses its investment-grade rating.
What are the implications?
If a country loses its investment-grade rating, it would face much higher costs for its future borrowing as its credibility will not be considered high and fewer lenders would want to invest. This loss of confidence would result in an outflow of funds from the equity markets as well because then investors would begin to have doubts about the economy as a whole.
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