Credit rating

Also called: Rating, Investment grade, Junk bonds · Topic: Financial Markets, Instruments, Insurance and Pensions · NCERT: Beyond NCERT

Meaning

A credit rating is a rating agency's view of how likely a borrower, or one of its debt instruments (such as a bond), is to pay back interest and principal in full and on time. The scale runs from AAA (safest) down to D (default). BBB- is the lowest investment grade, and anything below it is non-investment grade, often called "junk".

It matters because the rating sets the price of risk. A lower rating means investors ask for a higher yield, so borrowing costs more for governments, companies and the whole economy.

Explanation

How a rating works

• A Credit Rating Agency (CRA) studies the borrower's income, debt, cash flows and management. It then gives a letter grade.
• The grade can be given to:
• an issuer, such as a country or a company, or

• a single debt instrument, such as one bond issue.

• The ladder, from safest to weakest:

• AAA is the highest safety.
• BBB- is the lowest investment grade. Many cautious investors, such as pension and insurance funds, stay at or above this level.
• Below BBB- is non-investment grade, or "junk". The borrower pays high interest because the risk is high.

• D means the borrower has defaulted (failed to pay).

• The same idea can use different symbols. Moody's uses Baa3 for the lowest investment grade, which matches BBB-. Ratings may also be long-term or short-term (for example A-2 or A-3).

• An outlook (Stable, Positive or Negative) shows which way the rating is likely to move next.

Rating → credit spread → bond price

• Credit spread = the extra yield a riskier bond pays over a G-sec (government security) of the same maturity.
• Worked example (illustration):
• 10-year G-sec yield = 6.5%
• 10-year AAA corporate bond yield = 7.2%

• Credit spread = 7.2 − 6.5 = 0.7 percentage points (70 basis points). One basis point is one-hundredth of 1%.

• The riskier the borrower, the wider the spread.

• What a downgrade does to a bond's price (NCERT bond: Rs 100 face value, 2 years, 10% coupon; illustration):
• A downgrade makes investors want a higher yield. Say they now want 12% instead of 10%.
• The same fixed payments are discounted more heavily, so the present value falls.
• Price at 10%: 10/1.10 + 110/(1.10)² = Rs 100.00
• Price at 12%: 10/1.12 + 110/(1.12)² ≈ Rs 96.62
• Holders of the bond suffer a capital loss (a loss from a fall in the asset's price).

What moves a rating up or down

• Upgrade drivers: strong growth, fiscal consolidation (the government cutting its deficit step by step), good-quality spending on capital expenditure (capex), and healthy balance sheets.
• Downgrade drivers: rising debt, weak cash flows, and a higher chance of missing payments.
• Weak spot: the issuer-pays model.
• The company being rated pays the agency.
• The agency may then be tempted to give a softer rating to keep the client.
• As a result, ratings can lag behind reality.

In India

• Regulator: CRAs are regulated by SEBI under the SEBI (Credit Rating Agencies) Regulations, 1999 [2].
• Registered CRAs: CRISIL (1987, India's first), ICRA, CARE, India Ratings, Acuité and Infomerics.

• Acer Credit Rating Pvt Ltd was registered with SEBI on 21 August 2025 [3].

• Market share (2025-26): CRISIL gave the largest share of fresh ratings (about 46.8%), followed by ICRA (20.1%) and India Ratings (19.3%) [3].

• Failure case: IL&FS (2018). Its debt was rated AAA until shortly before it defaulted. This exposed the weakness of the issuer-pays model.
• India's sovereign rating (the rating of the Government of India's debt):
• S&P upgraded India from BBB- to BBB (Stable outlook) in August 2025. It also raised the short-term rating from A-3 to A-2 [1].
• This was S&P's first upgrade of India in 18 years. The previous one, in 2007, first lifted India to investment grade (BBB-) [1].
• S&P's reasons were strong growth, fiscal consolidation, better-quality public capex spending and healthy balance sheets [1].
• Morningstar DBRS had upgraded India to BBB (from BBB (low)) in May 2025 [1].

• Moody's rates India Baa3 and Fitch rates it BBB- (check the current status).

• Benchmark link: Indian corporate bonds are priced as the 10-year G-sec yield plus a credit spread that depends on their rating.

Don't confuse with

• Credit spread: the rating is a letter grade (an opinion). The spread is the extra yield in percentage points that the market actually charges. A lower rating usually leads to a wider spread.
• Interest-rate risk: credit risk is the risk that the borrower does not pay. Interest-rate risk is the risk that bond prices fall when market rates rise. Even a AAA G-sec carries interest-rate risk.
• Yield curve: the yield curve compares bonds of the same credit quality across different maturities. The credit spread compares different credit quality at the same maturity.
• BBB- vs BBB: both are investment grade. BBB- is the lowest step (India with S&P from 2007). BBB is one notch higher (India with S&P from August 2025) [1].

Prelims Hooks

• BBB- (Moody's Baa3) is the lowest investment grade. Anything below it is non-investment grade, or "junk".
• CRAs in India are regulated by SEBI, under the SEBI (Credit Rating Agencies) Regulations, 1999 [2]. Trap: the RBI does not regulate them.
• CRISIL (1987) was India's first CRA. In 2025-26 it gave about 46.8% of fresh ratings [3].
• S&P upgraded India to BBB (Stable outlook) in August 2025. This was its first upgrade since 2007, when India first reached investment grade [1].
• Morningstar DBRS upgraded India to BBB in May 2025, before S&P did [1].
• A downgrade widens the credit spread and pushes the bond's price down, because yield and price move in opposite directions.

Mains Points

• Rating governance and the issuer-pays conflict.
• The company being rated pays the rater, so ratings may be softened.
• IL&FS (2018) stayed AAA until shortly before it defaulted, which hurt mutual funds and the NBFC (non-banking finance company) market.

• Possible fixes: stronger SEBI rules on disclosure and rotation of raters, other ways of paying for ratings, and investors doing more of their own risk checks.

• Sovereign rating, fiscal discipline and cost of capital (GS-III).

• S&P's August 2025 upgrade was linked to fiscal consolidation and quality capex [1].
• A better rating → lower risk premium on Indian debt → cheaper borrowing for the government and Indian firms → more foreign investment into bonds.

• So fiscal discipline pays off directly in financial markets.

• Critique of sovereign ratings.

• India waited 18 years (2007 to 2025) for an S&P upgrade despite fast growth [1].
• This supports the view that global agencies give too much weight to deficits and debt and not enough to growth and payment history.
• It is one reason behind calls for more Indian and emerging-market voices in global rating systems.

Related concepts

• Bonds
• Coupon rate
• Present value
• Bond price and interest rate inverse relation
• Capital gain
• Zero-coupon bond
• Floating rate bond
• Mark-to-market
• Yield curve
• Inverted yield curve

Read more

• Bond basics: present value, coupon, yield and the yield curve