S&P's credit rating??????

Newspapers on August 6 carried the story of genesis of storm that has sent ripples across the financial markets around the world. Here is a sincere attempt to narrate, in simple words, what is this storm all about.

Before getting into the actual discussion, let us understand the meaning of a few required concepts.

Credit Rating - Credit rating implies rating the credit worthiness of a debt instrument (Corporate Credit Rating) or a national government (Sovereign Credit Rating). It is an index of the degree of risk of investing in the debt instrument or a nation. A better credit rating would mean higher creditworthiness and a lower risk of default and thus ensures the safety of principal invested. A lower credit rating would imply exactly the opposite. Credit rating is positively related to investor's confidence in investment.

Credit Rating Agency - Credit Rating Agency is an organization which assigns rating to the debt instrument or the nation, as the case maybe. It is to be noted that the credit rating is not the product of any mathematical computation but the outcome of long-standing experience of the agency. The credit rating agency evaluates the creditworthiness on the basis of qualitative and quantitative information gathered by the agency.

Example- Standard & Poor's (US), Moody's Investors Service (US), Fitch Ratings (US/UK), Japan Credit Rating Agency Ltd. (Japan), CRISIL (India) etc.

Fiscal Deficit - Fiscal deficit refers to excess of expenditure over income in the budget. A country with high fiscal deficit implies more of spending from the borrowed funds and vice versa. Investors would like to invest in those countries where fiscal deficit is low since the country, having less of borrowed funds is evaluated to have high credit worthiness.

The Issue-

Standard & Poor's is a high-ranked credit rating agency in the US. has downgraded the ranking it has assigned to US for the first time since 1917. US had been rated AAA, the highest of the ranking S&P gives to any entity. But now S&P has lowered the rating to AA+, one notch less than AAA.

The reason for the downgrade being the budget of US government. US govt proposed to reduce its fiscal deficit by $2.1trillion over 10 years. But S&P is of the opinion that the US govt should have proposed for the reduction of fiscal deficit by $4 trillion which is quite higher than the actual cut. This has made S&P feel that the US runs a high risk of public debt burden and downgraded the rating.

The downgrade has shaken the investor's confidence and given the focal point which US economy assumes in the world economy and the inter-linkage of financial markets, thanks to globalization, this downgrade has sent ripples across the financial markets around the world.