Explain to us the role of rating agencies

The spring verdicts from the rating agencies Moody’s and Fitch on French sovereign debt are expected Friday evening. The recently announced worsening of public finances suggests, at best, unflattering comments.

Moody’s and Fitch, two major rating agencies, will deliver their verdict on Friday April 27 on the financial health of France. Their rating could well punish France, whose budget deficit and debt are reaching worrying levels.

Rating agencies are private companies that evaluate the financial solidity of a state, a department, a municipality, and also private companies (banks, industries). The objective is to ensure that debts can be repaid by these states, these municipalities, these private companies. There are dozens of rating agencies, but only three of them have a global reach: the American Moody’s, Fitch and Standards and Poor’s.

A notation in the form of letters

The best rating is triple A: Germany and the Netherlands are among the rare “top of the class”. Afterwards, to put it simply, you have “AA”, upper average quality, “B” lower average quality, the lowest is “D”: the country is in default, it cannot repay its debts.

To establish their ratings, the agencies examine a country’s major economic and financial indicators, such as growth, budget deficit, debt, spending, or tax revenue. Once the note comes out, large investors will be guided in their choice to place money in this or that country, to invest in the debt of this or that state. If a country’s rating is disappointing, investors will theoretically tend to shy away from it and the country in question will have to increase its interest rates to attract investors, but it will then penalize its economy with high rates.

A “relative” role on investors’ choices

At Fitch, France’s rating was downgraded to AA – a year ago, before it was AA. The rating agency already estimated that our budget deficit is too large. In the other two agencies, France has lost its triple A rating for around ten years, while maintaining good grades despite everything.

France lost, for the first time, its triple A status in 2012. This episode was experienced as a real bolt from the blue, but it did not, at the time, scare off investors at all. Hence criticisms against rating agencies and their “relative” role. The agencies are paid by the companies they rate, which raises fears of a risk of conflicts of interest. Moreover, in 2007, rating agencies were criticized for giving good ratings to financial products, which subsequently triggered the subprime crisis.