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What do Moody's ratings mean anyway?

A bluffer’s guide to credit ratings and their impact.

Image: TheRichBrooks via Flickr

FINANCIAL NEWS today is dominated by the decision of the Moody’s investor service to downgrade Ireland’s rating from Aa1 to Aa2.

But what exactly does that mean – and will it hurt your pocket? Here’s our explanation of the whole thing.

Basically there are three main worldwide ratings agencies: Standard & Poor’s (or just ‘S&P’), Moody’s, and Fitch. Their jobs are to help investors assess the risk of investments in certain institutions, such as banks – or countries.

The basic function of these agencies, therefore, is to issue credit ratings. These, as you might guess, are broadly similar to the same credit rating an individual person might get.

If you’re good at making loan repayments or have a lot of money in the bank, you’ll get a good rating. If you struggle to repay your debts and don’t have much assets, you’ll get a lower rating and it therefore becomes tougher to borrow.

In essence, the credit rating of a country is just an impartial analysis of how safe it is to lend money to that country. And, as with people, those with higher credit ratings are more likely to negotiate better interest rates.

So how bad is an Aa2?

As the name might suggest, an ‘AAA’ (or “triple A”) rating is the best one the agency can offer, with progressively fewer As being given to lower rankings.

Ireland’s new score of Aa2 is still quite good, though – it’s the third-highest of the 21 different scores Moody’s assigns, and you need to get outside the top ten ratings before they start to refer to you as ‘junk’.

Investment in Irish bonds, according to the ranking, is of “very low credit risk”.

Moody’s actions today aren’t really that much of a shock, though – the move only brings the agency into line with the analysis of S&P and Fitch who have both degraded Ireland’s ratings in the recent past.

The change in rankings was also quite predictable given that the government has taken control of billions in debt through NAMA, meaning its future income is dependent on whether the unpredictable loans of developers and the like will be repaid.

So how will it hurt the country?

We’ll find out soon enough: Ireland is due to raise more cash for itself on world markets tomorrow, when it auctions off €1.5bn in debt in the form of ‘state bonds‘.

Investors buy a bond on the guarantee that Ireland will pay them a higher interest rate over its lifespan, and countries which are considered a risky investment are forced to offer higher interest rates to convince investors to opt in.

Naturally, of course, a higher interest rate means the government, through the National Treasury Management Agency, has to pay out slightly more – and needs slightly more income, through tax, to pay for it.

The last auction, in May, sold four-year bonds at an average rate of 3.11% and ten-year bonds at 4.72% – so we’ll be able to compare tomorrow’s results to that and see how the rating affects us then.

About the author:

Gavan Reilly

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