France downgraded by Standard & Poor

On Friday the credit rating agency Standard & Poor downgraded the ratings of 13 european countries, including France and Austria, which both lost their AAA grade.

But what does this all mean? And why is it important?

Credit rating agencies are private companies which study the data and give an unbiased opinion on how ‘safe’ a loan to a particular organisation – it could be a country or a business – will be. That is, how likely is it that the lender will be repaid on time and in full. Standard and Poor is one of the largest such agencies, and its opinions are taken very seriously.

The ‘AAA’ rating is the top rating available, and it basically means that the country is certain to be able to repay any loan it takes out. A lower grade , like ‘BB’, which is the mark given on Friday to smaller european countries like Portugal, means that prospective lenders should take into account a real risk that they may not get all of their money back. France’s new grade of ‘AA’ is still very good, as French President Nicholas Sarkozy has been quick to point out.

The grade matters because it is important in determining the interest rate at which governments are able to borrow money. A lower grade means that borrowing becomes more expensive, and could even mean that a country is not able to borrow money on the open market at a rate which it can afford. That is when a country needs to be rescued or ‘bailed out’ by an international lender like the International Monetary Fund.

France and Austria’s grades are particularly important at the moment because they are both guarantors of the European Financial Stability Fund, one of the key policy tools for dealing with the eurozone credit crisis.

Learn more about the international financial system at the Economics Summer School 2012.