Which is the highest rated debt paper in the world?
Well it is AAA.
However a country does not get its debt paper rated.
When I ask my class ‘why does a country not get its debt rated?’ I normally get a wrong answer….well not normally it is always!
Let us see why sovereign debt is not rated.
For a minute let us assume there are 2 entities. One is a company making automobiles, and one is the government. Both have excellent balance sheets and very good Profit and Loss account. Both Company A and Government B are rated AAA.
The only income for Company A is selling of cars. The only income for Government B is charging an entertainment tax on movies.
Suddenly people stop buying cars from company A and people stop watching movies!
Revenues of Company A and Government B drop to say, zero, or dramatically low. What happens to the ratings? Obviously Ratings will crash for both.
Company A starts making other products, downsizing, etc. – and will become a good company in 5 years. Till then the rating suffers…However, Government B finds out that the people are buying DVDs to watch movies, so overnight it brings a tax on DVDs!
The government has a plethora sources of revenue – tax on agricultural produce (when the economy is agrarian), then when it finds that people have shifted to manufacturing, Excise duty. Then when it finds that services are the biggest source of GDP, it levies service tax! Then there is profession tax, income tax, road tax….etc. etc.
What happens if you do not pay? Well it has a collection mechanism, the police and last it can jail the offender. Thus a government has many sources of revenue, a mechanism to enforce it, and a ability to track the businesses! In a worst case scenario it can print notes too. Hence we say ‘sovereign’ cannot default.
source:www.subramoney.com