A country’s credit rating score is determined by several economic, financial, political, and institutional factors. These components signal the country’s ability and willingness to meet its debt obligations. Sovereign credit rating agencies such as Moody’s, Standard & Poor’s (S&P), and Fitch consider the following factors:
1. Economic Factors
a. GDP Growth Rate
- Why It Matters: A strong and consistent economic growth rate signals a country’s ability to generate income and repay its debts.
- Key Indicators: Real GDP growth, per capita income, and sectoral contributions (e.g., agriculture, industry, services).
b. Economic Diversification
- Why It Matters: Countries with diversified economies are less vulnerable to external shocks, such as commodity price fluctuations or trade disruptions.
- Examples: Overreliance on a single export (e.g., oil, remittances) or sector increases risk.
c. Trade Balance
- Why It Matters: Persistent trade deficits can strain foreign exchange reserves and reduce repayment capacity.
- Indicators: Current account balance, export/import ratio, and trends in international trade.
2. Fiscal Factors
a. Debt-to-GDP Ratio
- Why It Matters: A high ratio indicates excessive borrowing relative to economic output, which raises concerns about repayment ability.
- Threshold: Ratios above 60–70% are often considered risky for emerging economies.
b. Budget Deficit
- Why It Matters: Chronic fiscal deficits suggest structural imbalances in public finances and over-reliance on borrowing.
- Key Metrics: Fiscal deficit as a percentage of GDP and trends over time.
c. Revenue Generation
- Why It Matters: Strong revenue collection (e.g., tax-to-GDP ratio) ensures governments can meet debt obligations without excessive borrowing.
- Weakness: Dependence on foreign aid or unstable revenue streams signals risk.
3. Monetary and Financial Factors
a. Inflation Rate
- Why It Matters: High inflation erodes investor confidence and weakens the domestic currency, making debt servicing more expensive.
- Key Indicator: Stable, moderate inflation rates are viewed positively.
b. Foreign Exchange Reserves
- Why It Matters: Adequate reserves ensure the country can meet external debt obligations and weather trade imbalances.
- Benchmark: Reserve coverage of at least 6–9 months of imports is considered healthy.
c. Exchange Rate Stability
- Why It Matters: Fluctuating or overvalued currencies increase repayment risks for foreign-denominated debt.
d. Financial Sector Health
- Why It Matters: A strong, well-regulated banking system reduces the risk of systemic crises, which could affect the government’s repayment capacity.
4. Institutional and Political Factors
a. Political Stability
- Why It Matters: Frequent changes in government, civil unrest, or corruption erode investor confidence and risk policy discontinuity.
- Indicators: Governance indicators, rule of law, and policy continuity.
b. Institutional Strength
- Why It Matters: Effective institutions ensure transparency, fiscal discipline, and accountability in public finances.
- Examples: Central bank independence, transparency in debt management, and regulatory frameworks.
c. Corruption and Governance
- Why It Matters: High levels of corruption discourage investment and increase inefficiencies in resource utilization.
5. External Factors
a. Current Account Deficit
- Why It Matters: Persistent deficits indicate reliance on external financing, which increases vulnerability to global shocks.
b. External Debt
- Why It Matters: High levels of foreign-denominated debt expose a country to exchange rate risks and refinancing pressures.
c. Global Economic Conditions
- Why It Matters: External shocks like commodity price fluctuations, global recessions, or trade disruptions affect debt repayment capacity.
6. Social and Development Factors
a. Income Levels
- Why It Matters: Higher income levels and broad-based economic participation reduce poverty and enhance domestic revenue generation.
- Indicator: Per capita income compared to global averages.
b. Human Development Index (HDI)
- Why It Matters: Investments in education, health, and infrastructure indicate long-term growth potential.
c. Demographics
- Why It Matters: A young, growing population is seen as an asset for economic growth, whereas aging populations strain public finances.
How These Factors Affect Credit Ratings
- High Credit Ratings (AAA, AA): Reflect strong economic fundamentals, low debt levels, and stable governance.
- Medium Credit Ratings (BBB, BB): Indicate moderate risks, often due to fiscal imbalances or weaker institutions.
- Low Credit Ratings (CCC, D): Suggest high default risks due to political instability, unsustainable debt, or economic crises.
Conclusion
Nepal’s credit rating score will depend on its ability to strengthen economic fundamentals, manage fiscal deficits, ensure political stability, and improve governance. A focus on revenue generation, export diversification, and reducing reliance on remittances will be critical to achieving favorable ratings in the global financial market.
