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Dubious ratings by credit rating agencies

There is an urgent need to voice forcefully against biased, unfair, and unabashedly faulty evaluation by the international credit rating agencies; there should be zero tolerance against such shabby treatment. — KK Srivastava 


Sovereign ratings attempt to highlight the credit worthiness of governments. They help the lenders to determine whether the borrowing government will honour its debt repayment commitments. Thus a country’s ability to borrow money from global investors hinges on good credit rating. If the rating assigned to a sovereign is low, the risk of default is high; consequently that government will have to borrow at higher cost.

Not only that, such ratings matter for all businesses of the country. This is because the government of a country is considered to be the least risky of all borrowers from that nation. Thus other businesses of that country - being considered potential borrowers with even higher risks – will have to pay even higher interest rate.

India – like other developing countries – suffers from a lack of capital; with a poor rating it will find it difficult to borrow from lenders. On one hand it will fail to utilize its other resources (labour, natural wealth, etc. which need to combine with physical and financial capital) for economic development. On the other, productivity will suffer, poverty will continue unabated, and so on.

That’s why sovereign credit ratings – and the 3 agencies, Moody’s, Standard & Poor, and Fitch – become important in determining not only the borrowing capability of a nation but even the path of economic progress. India, for long, has quibbled with the ratings assigned to it by these agencies. And it has good reasons to be aggrieved. According to the Indian government there are three man issues:-

One, these rating agencies adopt questionable methodologies which inherently appear to work against developing countries. For example, Fitch weighs banks with foreign ownership at a higher pedestal compared with public sector banks (which, according to it, face non economic considerations – political interference – in their working). In India of course these PSBs dominate. Besides, such basis of assessment ignores the welfare and development – functions that these PSBs perform, including spreading financial inclusion (e.g. Jan Dhan accounts – role of the financial institutions).

Two, the experts consulted for the acting assessments are selected in a non transparent manner, thus making the process of assessment even more opaque.

Three, the agencies do not specify the assigned weights for each parameter taken into consideration. Even if some numerical weights are assigned to such parameters (Fitch, for example, considers four factors – structural features, external finances, public finances, and macroeconomic outlook, policies and prospects – with respective ‘indicative’ weights), these weights may be for illustrative purposes only and need not reflect the actual weights assigned. In any case these indicative weights calculation are also based on false premises. Most of these weights are based not on hard real data, but they rely excessively on subjective appraisals. 

Hard economic data may not be used to arrive at these weights. For example, the weights may be based on such criteria as freedom of expression, freedom of media, rule of law, corruption, quality of regulation, etc. The lack of transparency in the assessment methods of the agencies makes it challenging to quantity the impact of qualitative factors on credit ratings. Over half the credit ratings are determined by the qualitative component. Most of these components, indeed, cannot even represent the sovereign’s willingness to pay.

If one was to access India’s financial strength and stability on financial parameters -   the most relevant ones – then India certainly deserves a better rating than what of late has been awarded to India by these three agencies. At the very least, India deserves an upgrade, in the background of India’s stellar economic performance both inter temporally and inter regionally. For example, Moody’s has shown concern with limited progress on India’s fiscal consolidation. While India’s fiscal deficit may not have been contained at targeted levels, there seems little danger of it spiraling out of control. The government is targeting a deficit of 4.5% by FY 26, down from 5.9% in the current year, which sounds realistic as tax revenues have been buoyant. Similarly, as per IMF assessment, the country’s debt levels could cross 100% of GDP by FY 28 (in the worst case scenario). But note that for the US, UK and China, the debt levels are pegged at 160%, 140% and 200% respectively. India’s general government debt – centre and states combined – has actually declined from 88% (2020-21) to 81% (2022-23). The government borrowings are expected to come down even further in face of encouraging trends in foreign investment inflows through bond market. Thus, if at all, the rating agencies need to revise significantly upward the weightage assigned to financial parameters, including foreign exchange reserves (very high currently) and very comfortable balance of payments.

India has been one of the highest and fastest growing large economies, moving steadily towards becoming world’s third largest economy in a few more years. It has never defaulted on loan repayment, including in worse circumstances. This is in background of the fact that in the past on several occasions it has been conclusively established that the rating agencies tend to be way behind the curve; they also exhibit herd behavior, more so in times of stress.

Good governance, democracy, ensuring citizens voice and accountability, rule of law, control of corruption all are desirable goals in themselves. But the ability to discharge debt is ultimately a function of a country’s macroeconomic fundamentals, such as GDP growth, inflation, government debt GDP ratio, fiscal and current account balance, external liabilities, forex reserve levels, and so on. Governance indicators (enjoying 68% weightage in India’s assigned credit ratings) rely on perceptions and value judgments. This means these rating agencies are seemingly suggesting that any improvement in macroeconomic parameters would matter little when it comes to sovereign credit rating.

Having said that, however, there is a scope for improvement for India No doubt the credit rating agencies need to be more objective, quantitative, and transparent in their ratings -  and thereby enhance their own credibility. But we need to address some questions too. First issue relates to data quality on which there is a debate currently on; legitimate questions have been raised, especially in the absence of Census data (the latest one became due in 2021, and there are no signs of it at least till the end of 2024, according to the latest reports) or household consumer expenditure survey (government results not after 2011-12). Second, while the general government debt at 82% (2022-23) is a good figure, remember that the same ratio was 77.2% in 2006 and 66.4% in 2010. Thus fiscal consolidation can certainly engage the attention of the government.

Efficient allocation of global capital certainly calls for playing the game on an even ground so that fair play is ensured. Rating agencies owe it to India.         

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