The uncertainty hanging over the creditworthiness of the world’s largest economy is the latest twist in the tale for investors being forced to re-assess countries that they once considered to be risk-free.

Before the financial crisis, danger that debt would not be repaid was associated mainly with developing economies, many of which had defaulted in recent decades.

To a large extent, the credit risk in developed and rich countries was pushed into the background – in particular for eurozone and US government bonds, which mostly carried top-notch triple A ratings.

“It bears reminding ourselves that a year ago it was widely believed that an advanced industrialised sovereign nation cannot default on its debt, that it was just not possible. That has changed,” says Bart Oosterveld, head of sovereign risk group at Moody’s Investors Service.

“However, there are few historical experiences you can test the developed country debt problems against. We are in uncharted territory.”

Without precedents to guide them, investors face greater doubts about how rating agencies will assess sovereign risk. In addition, the failure of the agencies to spot the risk in billions of dollars of mortgage-backed debt during the run-up to the financial crisis has put further pressure on the agencies to get it right now.

“Rating agency behaviour is getting harder and harder to predict as the crisis wears on,” says Win Thin, global head of emerging markets strategy at Brown Brothers Harriman.

Much of the uncertainty stems from the crucial role that politics plays in determining whether or not countries will honour their debts. Unlike the credit risks for companies or financial institutions, there is a much greater political dimension to assessing whether or not a country will honour its debts.

The downgrade by S&P of the US long-term debt rating was, in essence, an assessment of political risks. “Fiscal policy is at its core a political process,” says David Beers, S&P’s managing director of sovereign ratings.

Similarly, the collapse in credit standing of many of the eurozone peripheral economies and fears of defaults on eurozone government debt has resulted from political obstacles to resolving the region’s crises.

Yet even as downgrades are in the spotlight, there have also been sovereign upgrades. Most of the improvements have been in emerging economies – the shifts are resulting in a convergence of credit risks, making the previous distinctions between developed and developing economies less extreme.

“The real issue here is about the shifts in longer-term investment patterns and the potential impact on growth,” says Charles Diebel at Lloyds TSB.

“There is a strong latency bias in credit ratings, and most often one ratings move is not the end of the story. Unless there is a big shift from US policymakers, and likewise unless growth holds up, this could just be the first echo of the world re-balancing towards the east.”

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