More than a decade and a half ago, a senior government official wrote an article in a newspaper headlined ‘Moody’s or Moody’ — or words to that effect — on what was in his view the unjustified action of global credit ratings agency Moody’s in pushing down the sovereign credit rating of India.
Whether it is Moody’s or its peer Standard and Poor’s (S&P), Indian policymakers have often criticised the credit ratings assigned by these agencies.
This time, Moody’s has lowered India’s credit rating outlook from stable to negative because of what it has assessed as risks to economic growth, prospects of a more entrenched slowdown, weak job creation, and a credit squeeze being faced by Non-Banking Finance Companies. With growth slowing to 5% in the quarter to June this fiscal, and hardly any green shoots visible, most analysts may find it difficult to fault this assessment.
What do these ratings mean?
Credit ratings agencies rate on a scale the financials and business models of companies, as well as economic management by sovereign governments, after analysing official and other data and interacting with government officials, business leaders, and economists. These agencies then rate instruments such as bonds, debentures, commercial papers, deposits, and other debt offerings of companies or governments to help investors make informed decisions.
From a company’s or a government’s perspective, a better rating helps raise funds at a cheaper rate. The agencies do this on a continuous basis, either upgrading or downgrading the instrument based on performance, prospects, or events likely to have an impact on the balance sheet of a company or on the fiscal position of a government or a sub-sovereign entity.
Political uncertainty can trigger a sovereign rating downgrade. In August 2011, S&P cut the highest rating (AAA) of the US citing rising debt levels and political risks. This provoked a government official to comment that “this was a ‘facts be damned’ decision”.
Within the two categories of investment grade, which is for good-quality firms and speculative, there are several notches for companies whose financials pose a risk of defaulting on payments. India’s sovereign credit rating from Moody’s is now Baa2, with the outlook cut from ‘stable’ to ‘negative’.
This could potentially have an impact on companies planning to borrow overseas through bonds or foreign loans, for investors or banks abroad may well seek higher interest rates because of weak prospects. This usually weighs on institutional investors such as pension funds, endowment funds of overseas universities, or sovereign wealth funds that manage the wealth of rich countries.
They have to rejig their investments when there is a lowering of ratings. Firms and many governments that borrow from the international markets too are mindful of rating downgrades.
In India, the concern could be that after Moody’s upgraded its rating two years ago, when the economy grew two percentage points faster than now, the lowering could signal that a change upwards could be a long way off.
As the agency put it, compared with two years ago (when it upgraded India’s rating to Baa2 from Baa3), the probability of sustained real GDP growth at or above 8% has significantly diminished. It explained that the decision to lower the rating was based on increasing risks that growth will remain materially lower than in the past, leading to a gradual rise in the debt burden from already high levels.
Does a downgrade really matter?
That depends on how and where governments borrow. Many countries tap the global debt or credit markets to raise money. Global banks or their investment banks often claim that it is important to diversify their investor base, be it companies or governments, to lower the risk of a narrow set buying into such borrowing programmes and posing a risk of selling or pulling out.
India has been an outlier on this count. It has not issued a bond or raised money directly in the international market so far, which means that to a good extent, a downgrade has limited impact. Rather, the impact is felt almost fully by private firms or state-owned companies which raise foreign currency funds.
In this year’s Budget, the government announced its intention to go in for a sovereign bond, but hasn’t moved on it yet in the backdrop of criticism and caution by the RBI. In the past, Indian policymakers with long memories had stymied attempts to issue a sovereign bond or borrow from the international market directly. And one of the reasons for that has been what they perceive as the alleged bias of credit ratings agencies.
Consider this. In the run-up to India’s balance-of-payments crisis in 1991, the agencies swiftly downgraded the sovereign rating, thus reducing the country’s ability to raise money abroad through public sector oil companies or banks for short periods to buy oil or to pay for imports. In 1998, when India announced that it had carried out nuclear tests in Pokhran, the ratings agencies were quick to react again, impacting borrowings.
The government and the RBI then decided to ignore these agencies and raised billions in foreign exchange through bonds issued by the SBI in two tranches. It helped that the government did not have foreign borrowings. And for long, the Indian government did not engage much with credit ratings agencies in trying to change perceptions. This was until after 2004-05 or so onwards, with the growth uptick that lasted for well over six years.
How credible are the agencies?
Credit ratings agencies have taken a knock after the global financial crisis of 2008, when they were exposed after the collapse of highly rated banks and other institutions. Since then, they have come under attack in India too, and also faced regulatory action, besides a probe by central investigating agencies after they had assigned top ratings to borrowings by firms that were part of the IL&FS group last year.
Just a year before the last sovereign rating upgrade by Moody’s in 2017, Shaktikanta Das, who was the Secretary, Economic Affairs then and is now the RBI Governor, had written to the agency raising questions on its methodology and making out a case for revisiting it. The Finance Ministry’s point then was that India’s debt levels had declined, and that it ought to reflect in the ratings metric. Often, the government has also complained that countries with higher levels of debt and a weak fiscal have managed better ratings.
This time, the government has responded to the change in outlook by saying that India’s fundamentals are robust and that other macroeconomic indicators such as inflation are still low, which is reflected in low bond yields, with growth prospects strong both in the near and long terms. Essentially, it has indicated that it does not agree with the assessment of the agency. Whether the financial markets share a similar assessment, is what needs to be seen over the next few weeks.
India’s policymakers have often grumbled about the “moody” nature of credit rating agencies and their seemingly differential standards. But it is useful to keep in mind the fact that despite the sovereign ratings being what they have been for a long time, India has attracted plenty of portfolio and flows into both government and corporate debt, besides Foreign Direct Investment. A rational approach should help.