A tale of many ratings
In August 2011, international rating agency Standard and Poor’s (S&P) cut the long-term credit rating of the US by one notch from AAA to AA plus. This was the first time that the US lost its top-tier rating in 70 years, putting it behind more than a dozen countries, including Australia, Canada and Germany. The rating downgrade was also accompanied by a change in outlook from “stable” to “negative”. This was a big jolt, not to mention loss of prestige for a country which is considered the epicentre of the global financial system.
For any other country, a downgrade in sovereign ratings would imply that investors would become reluctant to hold its bonds, and yields would have to rise so as to attract buyers into the government bond market. The result of the downgrade was quite the opposite. US bonds rallied by more than 15 basis points on the very next trading day, and over the course of the next 200 days, the cost of borrowing for the US government dropped by 14 basis points. Four years later, the return on US bonds, including capital gains, was a healthy 11%, contrary to what the rating downgrade would have implied. If any investor had chosen the conventional approach of shunning US bonds after the downgrade, it would have been a foolish financial decision. It turns out that this anomalous behaviour was not confined to the US bond rating downgrade alone.
Bloomberg’s analysis shows that even in downgrades of Austria, Japan and New Zealand, a similar phenomenon was observed: a bond rally following the downgrade, and reduction in the cost of government debt in the medium term. Indeed, the same analysis covering 314 upgrades, downgrades and outlook changes over a long period of 38 years showed that bond prices moved in the opposite direction from the expected in at least half of all cases.
In India, too, we saw a similar reaction to Moody’s recent rating upgrade. This was India’s first sovereign upgrade in 13 years, and hence a time for much celebration, and expectations of a bond rally. But on the same day as Moody’s decision, the Reserve Bank of India had to cancel an auction sale of Rs10,000 crore of government bonds, over concerns of yields rising. Thus, at least in the short run, the bond yields had moved in the opposite direction. Moody’s rating action has also come at a strange time. Currently inflation is inching up, there is a possibility of considerable fiscal slippage and the sovereign debt is rising. Of course, sovereign rating agencies are not supposed to be influenced by such short-term dynamics, and they look at longer-term prospects. But even then the timing is rather odd, or possibly six months too late.
Indeed, the chief economic adviser to the government of India had chided international rating agencies for their inconsistent and unfair treatment of India. Looking at the same debt dynamics of the country, the rival agency, S&P, has chosen to keep India at the lowest investment grade of BBB minus. It says that India is the poorest (in per capita terms) among all sovereign peers with the same rating, and S&P is concerned about India’s fiscal challenges and the net debt position. High growth is the only comforting factor.
Ironically (and perhaps inexplicably), the same S&P gave India a higher rating back in March 1991, when India was on the brink of default, growth was stagnant, and its fiscal and external situation was in near crisis. When asked about this inconsistency, the S&P response has been (informally) that either their “standards” have gotten tougher, or the total country sample is doing better in relative terms. But even this defence can be questioned, since in October this year, S&P upgraded Italy above India, even though Italy’s debt (133% of gross domestic product) is twice that of India’s (69%). Italy’s growth and unemployment performance is far worse than India’s.
Two weeks after that historic downgrade of the US, the chief executive officer of S&P had to resign. The firm was also indicted for misleading investors during the Lehman crash and financial crisis of 2008. These may be unrelated—surely there is no political pressure on the rating action.
This is not the place to pick holes in the rating models of S&P or Moody’s. But rather to reiterate that India has its work cut out, external rating notwithstanding. India has never floated a dollar bond internationally, nor does it intend to. There has been a record inflow of foreign direct investment despite India’s low rating all these years, even before the recent upgrade by Moody’s. Obviously, investors don’t wait for guidance from rating agencies.
Speaking of external validation, India recently also got huge recognition in a jump of 30 ranks in its global ranking in ease of doing business by the World Bank. The ease of doing business ranking began around the same time that a new acronym was coined internationally. This was BRIC (Brazil, Russia, India and China), the foursome of fast-growing large economies. The fact was that all these fast-growing economies were ranked well below 120 or 130 for their ease of doing business in the early years of ease of doing business ranking. Clearly, global investors or BRIC growth rates were not paying attention to global rankings!
This is not to take away the content and meaning of ease of doing business ranking, but to make the same point: An external rating or global ranking is useful, but markets and investors make their own decisions. Ratings agencies are often lagging indicators. And policymakers need not be distracted by them. They have much work to do on the internal reform agenda.
Ajit Ranade is chief economist at Aditya Birla Group. Comments are welcome at email@example.com
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