Opinion | Sovereign rating is not just about finance
It’s the combination of a country’s institutional and economic profile that is relevant for achieving superior rating
A sovereign rating exercise is not just about assessing a country’s financial soundness. Non-economic fundamentals are equally important in determining a sovereign rating. It’s the combination of the country’s institutional and economic profile that is relevant for achieving a superior rating. Rating agencies conduct analysis on non fiscal aspects such as effectiveness of policy making and strength, and stability of its civil institutions. The discussion below is focused on assessment of institutional effectiveness and delivery.
The institutional rating framework is fairly comprehensive, assessed both at the federal and state levels. The assessment is undertaken on a scale of 1 to 6, with 1 being the strongest and 6 the weakest. For achieving a high sovereign rating, institutions need to be seen as proactive, possessing strong track record and perception, implementing reforms, promoting a cohesive civil society, social order and inclusion. There is a transparency check undertaken on the government’s reported data for its validity, reliability and credibility. The S&P, in its sovereign rating methodology, has listed the nation’s ability to implement key reforms with regard to healthcare, pension, monetary policy, public finances and external pressures, apart from policymaking, the judiciary and accountability. Institutions must have independent mechanisms free of corruption and interference, and should help sustain growth. Policymaking needs to be perceived as free of interference by successive governments. In this context, the world is keenly watching rating actions on policy reversals by successive governments in some advanced economies on climate change and Brexit.
A country needs to be seen as promoting unbiased enforcement of contracts and having respect for the rule of law in property ownership, and in creditors’ and investors’ interest. A part of the assessment is on the ease of doing business blended with a green way of doing business. The country’s economic growth also needs to reflect its less carbon-intensive nature. Strong institutions generate investor-lender confidence and help bring certainty in contracts. The recent jump in India’s ease of business ranking by 23 notches is an acknowledgement that reforms have the potential of pushing India’s rating upwards.
Institutional effectiveness is judged on macro prudential outcome over micro prudential output. Rating agencies undertake increased scrutiny in conducting effectiveness exercise as both actions and inactions are judged for outcome. In an Indian context, initiatives such as Swachh Bharat, metro rails, freight corridors, cleaning of rivers, digital banking, soil-strengthening, goods and services tax rollout, bankruptcy reforms, and bank recapitalization have the potential of pushing for a rating upgrade. India’s projected gross domestic product (GDP) growth may make it the world’s fourth largest economy in the coming years, but its investment grade rating is not yet reflective of its true potential. Despite India currently being the world’s fifth largest economy by GDP, its rating is second lowest after Brazil among the world’s 10 large economies. India’s per capita income is the lowest among the top ten economies by GDP. Further, implementation of institutional reforms, especially at state and municipal levels, can bring credibility to India’s institutional-effectiveness culture and delivery.
Some key questions come up on macro prudential outcome. How is the judiciary perceived? What is the average justice delivery time compared to an AAA-rated country? Long overdue judicial reforms for timely justice delivery once implemented have the potential of upping India’s rating. Ongoing developments pertaining to the Central Bureau of Investigation’s governance are a concern. Interventions by the Supreme Court, the Central Vigilance Commission, and the government will be judged for the outcome with regard to India’s ability to handle delicate governance situations. Is access to healthcare affordable? Do we have sufficient healthcare delivery infrastructure compared to an AAA country? Ayushman Bharat is a key event that upon successful implementation can push India up the rating ladder. The recent spat between the Reserve Bank of India and the government is a healthy sign if the outcome is preserving RBI’s independence while facilitating informed and well reasoned decisions.
Contentious issues include: If a rating agency is independent enough and free of conflict to rate civil institutions? Could a rating agency be influenced by its shareholders or regulator? Is evaluation done on local or offshore perceptions? Which body will take a call for an adverse rating action influenced by subjective judgement? Developing economies have frequently called for multilalteral interventions in determining a sovereign rating methodology, ownership and supervision of rating agencies. Being independent and unbiased, a multilateral rating system will generate confidence .
Is superior rating solely the responsibility of the federal government? While the federal government would be responsible for fiscal performance and enabling environment, collective and participatory approach of citizens, a cohesive civil society and stakeholders are equally necessary. State governments could up the ante for delivery of quality municipal, urban and rural services. Active participation of legal, medical, governance, accounting and business professionals will make institutions responsive and relevant. Of course, an independent and free press is a prerequisite—existing abundantly in India and making citizens proud.
Ajay Sagar is a former senior staff of Asian Development Bank, Philippines. Views are personal.
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