Dear Mr Moily,
I was so overwhelmed by a complex range of emotions after your comments a month ago that it has taken me this long to regain my composure and write to you.
You were incensed by credit rating agencies using the quality of political leadership as one of the criteria for rating the sovereign, and warned them to refrain from taking this approach.
First, surprise. Knowing fully well how intolerant some of your ilk could be, no rating agency issued an apology or a promise to mend ways. Kudos to you—you proved you are far more liberal than the bunch chafing at some antediluvian cartoon.
Secondly, congratulations. You join the rarefied club of remaining individuals who take rating agencies seriously enough to warrant such strong reactions.
Thirdly, condolences. You joined P. Chidambaram and Jairam Ramesh in bidding for the finance minister’s post through sundry expressions of knowledge on the financial sector and the economy, but Madam graced only Chidambaram. No harm in attempting; even Baba Ramdev does it occasionally.
But as a person who has worked in a related industry for a better part of the last two decades, let me offer some gratuitous insights on this rating business. You will realize that you ought not to shoot the messenger; it is just that the message is transmitted in a difficult-to-comprehend garbled language.
Their main job is to estimate the probability of default, in this case, default by a country. For that, they subject the financial data of the country to stress-testing by complicated mathematical models. It is good they do not disclose those details, else lesser mortals like us will be mortified by them.
But many years ago, they discovered just that is not going to work. Models are broadly the same, data feed exactly the same, so how does one provide a unique spin to the default risk story? You see, sir, our fraternity has to perennially answer the question “How are you different?”
First, they realized they needed to make forecasts. Step no. 1 to subjectivity.
Secondly, they needed to understand and distinguish between ability and willingness to honour debt-repayment commitments. Unfortunately, they have not been able to develop any mathematical model to capture these aspects, particularly the latter. So perforce they have to look at qualitative factors, which is quality of management for a company and of political leadership for a country.
So in the end, the rating is probably more qualitative than mathematical. Yes, I know it is very irksome. One cannot quarrel with an equation, but when it comes to subjective judgment, it can inflame a lot of passion. Particularly hard in a society that reveres authority and looks at leaders deferentially.
Why this obsession with leadership quality for a country? After all, a country is not a limited liability company! The answer is that our institutions are not robustly implemented though magnificently designed. Perhaps it is the characteristic of a young nation. As sociologist Dipankar Gupta would put it, we still have to depend on Mahatmas. Developed nations, if there are genuinely any, are run by their Atmas, that it, their institutions. An example that will appeal to you is how the leadership (read CEO) of a state-owned bank can make or break it. The only reason for the fortunes of a 50,000-strong bank to be so disproportionately dependent on the leadership is that its processes are not properly institutionalized.
Oh, you must be worried that India and then its companies will have to borrow abroad at a higher cost if the country rating goes down. Well, this is only partly true. The financial market does not wait for a rating downgrade to ratchet up lending rates for an entity. They follow the very same signs and keep taking decisions on their own; a stamp of approval from a rating agency just adds some punch. In India, even banks ignore signals from the Reserve Bank of India (RBI), and raise or lower rates much before RBI changes policy rates. India’s stock with international lenders and investors has already been down for several months now. A rating downgrade will at best be ho-hum.
So, sir, please do not hyperventilate over sovereign ratings at this juncture. I am told you have plenty to do, not considering your side-responsibility of the power portfolio. Apparently you are trying to get a recalcitrant Companies Bill converted into a law. After the post-Satyam lull, the Adidases, OnMobiles and Deccan Chronicles have started tumbling out, your Serious Frauds Investigation Office is becoming very serious. Some research analysts have already predicted a few more upcoming Satyams by detecting corporate governance shortcomings, among other things. You can take comfort in the knowledge that many of these are also based on assessments of management quality.
Dipankar Choudhury is former director of Indian Financial Services Research at Deutsche Bank, and is an independent consultant focusing on banks and financial services.