Ratings: India has a valid reason to be aggrieved

Our post-pandemic economy has fared impressively and macro variables look healthy, but Standard & Poor’s still rates India ‘BBB-minus,’ unchanged since 2007; ditto for Fitch, which last made a change in 2006.
Our post-pandemic economy has fared impressively and macro variables look healthy, but Standard & Poor’s still rates India ‘BBB-minus,’ unchanged since 2007; ditto for Fitch, which last made a change in 2006.

Summary

  • The CEA’s office has highlighted opaque and subjective inputs for sovereign ratings and the raw deal that India gets. Credit rating agencies, please note: Efficient allocation of global capital calls for a level credit field.

There has been much debate over the sovereign credit rating India deserves. New Delhi has long lamented that rating agencies have been unjust in assigning the country their lowest investment grade. Re-examining Narratives: A Collection of Essays, released last week by the Chief Economic Advisor’s office, attempts to explain why these agencies are wrong. Its first essay focuses on their opaque methodologies that over-rely on qualitative factors to assess the will of debtors to pay back debt (beyond the ability to do so). If mental short-cuts and biases creep in, then bad calls are sure to follow on which nation-states are how worthy of credit. While the essay’s basic argument is about emerging economies getting a raw deal from the big three, all based in the West, India’s weak ratings are what it principally questions. Our post-pandemic economy has fared impressively and macro variables look healthy, but Standard & Poor’s still rates India ‘BBB-minus,’ unchanged since 2007; ditto for Fitch, which last made a change in 2006. Moody’s rating is still ‘Baa3.’ We have foreign exchange reserves piled above $600 billion, our capital inflows are robust, external balances are manageable and obligations under no strain. Government debt, at about 80% of GDP is largely internal and hardly outsized for a fast-growing economy. Indeed, the far bigger burdens of richer countries get little reproach, even if they openly flirt with default.

Not only has Independent India never defaulted on its debt obligations, but taken care not to get into a tight spot after a scare back in 1990-91. The difference in treatment by rating agencies can be attributed mostly to abstract aspects of their analysis, which go heavily by governance reviews that cover institutional strength, rule of law, level of corruption and so on. The trio “fail to clearly distinguish between the indicators used to assess ‘ability to pay’ and ‘willingness to pay’, making it complicated to evaluate the assigned credit ratings," observes the essay. A join-the-dots study aimed at finding the extent to which fiscal performance, external debt variables, monetary variables, national income and governance factors impact ratings found that the last of these account for over two-thirds of India’s score. Since rating formulas are hazy at best, it’s hard for anyone to work out if that estimate is correct. If the big three want to contest it, though, they should make their methods fully transparent and explain. Country evaluations are even more complex than corporate ratings, and their record on the latter is chequered: Recall their failure to warn of US debt turmoil in 2007-08 that led to a Great Recession and exposed conflicts of interest arising from their advisory and rating roles.

‘Ratings capture,’ like its regulatory variant, is a recipe for mishaps. Yet, credit ratings still hold significance. They influence the cost at which a government can raise funds and thus how cheaply private entities under its governance can borrow. These labels also shape global flows of capital, and India needs to make productive use of such money to lift its economy and reduce poverty. Although parts of the essay border on over-sell, it makes a cogent case for an upgrade of a country with no blots on its repayment record and its covid-stretched public finances on a recovery path. Rating agencies should read it and ask themselves whether lumping India with a bloated risk premium helps optimize the allocation of global capital. Efficiency demands a level credit field.

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