Short answer: Credit ratings are independent opinions on the probability of default. In India, they influence pricing (spreads), eligibility (who can invest), and capital charges for banks—so they move markets. Ratings are regulated by SEBI, used by RBI for risk weights, and should be a starting point, not the sole basis for investment decisions.
Last updated: August 15, 2025
What is a credit rating?
A credit rating measures the likelihood of timely repayment of interest and principal. Long-term scales run from AAA (highest safety) to D (default), while short-term scales use A1+/A1/A2…. SEBI has standardised symbols and definitions across Indian CRAs.
Investment grade vs sub-investment grade
- Investment grade: BBB- and above
- Sub-investment grade: BB+ and below (higher risk, higher spreads)
SEBI’s Master Circular codifies symbol standardisation, withdrawal rules, conflict-of-interest firewalls, and disclosure obligations.
Why ratings matter for Indian markets
1) Pricing of bonds and loans
Lower default risk → lower yield spread.
Spread formula:
Credit Spread = Corporate Bond YTM – G-Sec YTM (same tenor)
2) Who can invest
Mandates for insurers, pension funds, and many mutual fund schemes often require minimum ratings. Municipal bonds and many public debt issues must be rated before issuance. (Ministry of Housing and Urban Affairs, IndiaBonds)
3) Bank capital & credit growth
Under RBI’s standardized approach to Basel, banks assign risk weights to rated exposures using ECAI ratings. For example, exposures to NBFCs are risk-weighted “as per external ratings,” and RBI has adjusted add-ons to manage systemic risk. Result: ratings affect capital consumption and the cost/availability of credit.
4) Mutual fund NAVs & market sentiment
Downgrades widen spreads, trigger mark-to-market losses, and can force sales in rating-constrained portfolios (e.g., credit risk funds). SEBI’s post-default “curing period” guidance shapes when a fund can recognise an upgrade from ‘D’. (Securities and Exchange Board of India)
How reliable are ratings? (Data, not vibes)
CRISIL’s FY2014-FY2024 study shows clear ordinality—higher ratings default less. Selected one-year cumulative default rates (CDR):
| Rating | One-Year CDR |
|---|---|
| AAA | 0.00% |
| AA | 0.05% |
| A | 0.07% |
| BBB | 0.52% |
| BB | 3.01% |
| B | 8.25% |
| C | 24.20% |
Notably, no long-term AAA default is observed over one-, two-, or three-year windows in the dataset. Past performance is not a guarantee, but the gradient is informative for pricing and risk budgeting.
Key regulations Indian investors should know
- SEBI Master Circular for CRAs (May 16, 2024): Standardises symbols/definitions; mandates firewalls with non-rating entities; details rating withdrawal and disclosure norms.
- “Issuer Not Cooperating (INC)” tag: If an issuer withholds information, CRAs must suffix the rating with “ISSUER NOT COOPERATING” and may be required to downgrade to non-investment grade after persistent non-cooperation. Treat INC as a red flag. (CDSL India, krestonsgco.com)
- Post-default curing period: After curing a default, a CRA generally requires ~90 days of satisfactory performance to move from ‘D’ to non-investment grade; policy-based deviations permitted. (Securities and Exchange Board of India)
- Basel risk weights: Banks’ capital requirements depend on external ratings (ECAIs). RBI has periodically tightened risk weights for certain segments, directly linking ratings to system-wide credit costs.
- Municipal bonds—EL ratings (2025): SEBI now allows Expected Loss (EL)-based ratings (alongside traditional PD ratings) for muni bonds financing infrastructure—helpful where recovery prospects matter as much as default odds. (Securities and Exchange Board of India)
How ratings move markets: two quick scenarios
A) Downgrade ripple in debt funds
If a AA issuer is cut to BBB, spreads can jump. Suppose a 3-year AA NCD yielding 8.2% widens 120 bps post-cut; its price falls to re-price the higher yield, denting mutual fund NAVs that hold it. The downgrade also restricts who can own it (mandate breaches), magnifying selling pressure. (Mechanics shaped by SEBI’s curing/INC rules and CRA disclosures.) (Securities and Exchange Board of India, CDSL India)
B) Bank capital & lending appetite
When risk weights rise for exposures where ratings imply sub-100% risk weight, banks must hold more capital for the same loan book. Lending rates can rise or limits tighten—especially for lower-rated NBFCs—spilling into spreads for primary bond markets.
Expected Loss (EL) vs Probability of Default (PD)
- PD rating: Focuses on likelihood of default over a horizon.
- EL rating: Incorporates recovery; the textbook relationship is
EL = PD × LGD × EAD,
where LGD is loss given default and EAD is exposure at default.
SEBI’s 2025 circular extends EL-based ratings to municipal bonds—useful where ring-fenced cash flows and recoveries (escrow, project revenues) drive outcomes. (Securities and Exchange Board of India)
Common pitfalls & lessons from past episodes
- Rapid downgrades after stress emerges: IL&FS and DHFL episodes highlighted pro-cyclicality and surveillance gaps; SEBI has since tightened governance and disclosure and penalised CRAs. Investors should still read press releases and rationale—not just symbols. (mint, Securities and Exchange Board of India)
- INC complacency: An INC tag signals limited information access—treat as a caution sign even if the symbol still reads investment-grade. (CDSL India)
Practical checklist for Indian investors
- Start with rating, invest on research: Use ratings to screen; read the rationale, outlook, and key risks in the press release.
- Watch for “INC”, “Credit Watch”, and outlook changes: Early warnings matter more than the eventual downgrade. (CDSL India)
- Mind the mandate: For debt funds, ensure holdings fit your risk tolerance; downgrades can cause NAV volatility. (Securities and Exchange Board of India)
- Spread sanity check: Compare bond yield to same-tenor G-Secs; unusually high spreads for the rating often hint at latent risks.
- For muni/infra bonds: Consider EL ratings and recovery mechanics (escrows, guarantees), not just PD. (Securities and Exchange Board of India)
FAQs
Are credit ratings guarantees?
No. They are opinions based on current information and can change. SEBI requires ongoing surveillance and standardised disclosures, but uncertainty remains.
Can AAA default?
Theoretically yes, but CRISIL’s long-term AAA shows no one- to three-year defaults in the FY2014-FY2024 window. Still, treat AAA as very low risk, not no risk.
What does “Issuer Not Cooperating (INC)” mean?
The issuer isn’t sharing information; the rating must carry the INC suffix and, if non-cooperation persists, CRAs may downgrade to non-investment grade. (CDSL India, krestonsgco.com)
Why do banks care so much about ratings?
Because RBI uses external ratings to set risk weights, which determine capital that banks must hold—impacting loan pricing and availability.
What changed in 2025 for municipal bonds?
SEBI enabled EL-based ratings for muni bonds financing infrastructure, adding a recovery-aware lens alongside PD ratings. (Securities and Exchange Board of India)
Bottom line
In India, credit ratings are a market plumbing utility—shaping spreads, access, and capital. Use them as a compass, not a GPS: check the press release, outlook, INC flags, and spreads before committing capital, and size positions to your risk budget.
Sources
- SEBI Master Circular for CRAs (May 16, 2024) — symbols/definitions, firewalls, withdrawals, disclosures.
- CRISIL Default & Transition Study FY2024 — default rates by rating; ordinality.
- RBI (Nov 16, 2023) circular — risk weights and ECAI linkage for bank exposures.
- SEBI (May 21, 2020) circular — post-default curing period. (Securities and Exchange Board of India)
- SEBI (May 15, 2025) circular — EL-based ratings for municipal bonds. (Securities and Exchange Board of India)