Reforming sovereign credit rating process need of the hour: CEA

  • Finance ministry officials have met representatives from the top three rating agencies seeking an upgrade of India’s sovereign credit rating

Rhik Kundu
Published21 Dec 2023, 06:49 PM IST
Chief economic advisor V Anantha Nageswaran said enhanced transparency in credit ratings may compel the use of hard data and likely result in credit rating upgrades for a good number of sovereigns (PTI)
Chief economic advisor V Anantha Nageswaran said enhanced transparency in credit ratings may compel the use of hard data and likely result in credit rating upgrades for a good number of sovereigns (PTI)

Credit rating agencies need to reform their sovereign rating process to correctly reflect the default risk of developing economies, saving billions in funding costs, the government’s chief economic adviser, V Anantha Nageswaran, said on Thursday.

His comments coincide with India seeking an upgrade to its sovereign credit rating, currently at the lowest possible investment grade, as the South Asian nation has seen its economic metrics improve considerably since the pandemic.

In a document titled Re-examining Narratives: A Collection of Essays, published by the CEA's office, Nageswaran said the enormous degree of opaqueness in credit rating methodologies makes it challenging to quantify the impact of qualitative factors on credit ratings. 

“The significant presence of qualitative factors in credit rating methodologies also gives rise to bandwagon effects and cognitive biases amply reflected in various studies, generating concerns about the credibility of credit ratings,” he added. 

Nageswaran’s comment comes as the government continues to engage with prominent global credit rating agencies to improve India’s sovereign credit rating. 

To that extent, finance ministry officials have met representatives from the top three rating agencies–Fitch Ratings, Moody’s Investors Service and S&P Global Ratings–seeking an upgrade.

 A sovereign credit rating is a measurement of a government’s ability to repay its debt, with a low rating indicating high credit risk. 

While S&P and Fitch rate India at BBB, Moody’s rates the South Asian country at Baa3, which indicates the lowest possible investment grade, albeit with a stable outlook.

Typically, rating agencies use various parameters to rate a sovereign. 

These include growth rate, inflation, government debt, short-term external debt as a percentage of GDP, and political stability. 

A quantitative analysis showed that over half the credit ratings are determined by the qualitative component, Nageswaran said in the document. 

“Institutional Quality, proxied mostly by the World Bank’s Worldwide Governance Indicators (WGIs), emerges as the foremost determinant of a developing economy’s credit rating, which presents a problem since these metrics tend to be non-transparent, perception-based, and derived from a small group of experts, and cannot represent the willingness to pay of the sovereign,” he wrote. 

“Their effect on the ratings is non-trivial since it implies that to earn a credit rating upgrade, developing economies must demonstrate progress along arbitrary indicators while simultaneously contending with the discriminations the ratings tend to carry,” he added. 

Nageswaran emphasised that while a sovereign is obligated to be completely transparent, establishing symmetry of obligations warrants that the rating agencies make their processes transparent and avoid employing untenable judgements. 

“Enhanced transparency in credit rating may compel the use of hard data and likely result in credit rating upgrades for a good number of sovereigns,” he said. 

“This will help them access private capital, which has been assigned the central role by G-20 in addressing global challenges such as climate change and supporting the energy transition,” Nageswaran added. 

On global trade, Nageswaran said India’s export targets had become achievable due to schemes such as the production-linked incentive schemes, Make in India, and new-age free trade agreements. Also contributing to this were fundamental drivers of exports such as price competitiveness, access to markets, and development of markets for niche products, even amid a slowdown in global trade. 

The Bharatiya Janata Party government headed by Prime Minister Narendra Modi has set an export target of $2 trillion by 2030, offering benefits to boost exports of electronics, engineering, pharmaceutical, and other goods.

India’s net exports stood at $443.72 billion during FY2023, impacted by a slowdown in global growth.

The tightening of interest rates due to nagging inflation, especially in advanced Western economies, has led to a slowdown in business, investment and trade.

According to the latest data from the commerce ministry, the merchandise trade deficit fell from $31.46 billion in October to $20.58 million in November. This was because of a decline in imports to $54.48 billion in November from the $65.03 billion recorded in October. 

Exports, meanwhile, rose marginally to $33.90 billion in November, compared with $33.57 billion in October.

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First Published:21 Dec 2023, 06:49 PM IST
HomeEconomyReforming sovereign credit rating process need of the hour: CEA

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