In the movie The Big Short , based on the book by the same title, there is a fascinating scene where one of the protagonists, who runs a hedge fund, meets a top executive of a ratings agency. In a world that is on the brink of the global financial meltdown, the protagonist asks the analyst why she gave such high ratings to the highly ‘toxic’ credit products hawked by a big bank. The analyst in an unwitting moment, confesses that if she didn’t give a good rating, the bank would have gone to another rating agency and got a ‘good rating.’ This extraordinary ‘confession’ made the protagonist conclude that the very edifice of American capitalism rested on a gigantic fraud!
After the 2008 global financial crisis, which brought the global economy to its knees, the role of ratings agencies along with that of the big banks came under much scrutiny. How did these prestigious ratings agencies, staffed by such financial whizzes, not see the danger lurking behind the ‘toxic’ financial products going around in the market? How did these agencies give high ratings to products that were so obviously flawed?
In India too, the role of the ratings agencies came into question when some prominent NBFCs defaulted on their debt obligations. But despite such egregious errors, over which banks collapsed and people lost jobs, savings, and their houses in the West, ratings agencies emerged from the global financial crisis relatively unscathed. Their reputational damage, if any, was marginal as their ratings and analyses are still much sought after.
Under scrutiny
In this context it is interesting to see this year’s Economic Survey, which is largely the work of the Chief Economic Advisor and his team, devote an entire chapter on ratings agencies and their work. The chapter’s title too has a rather angry tone — ‘Does India’s Sovereign Credit Rating reflect its fundamentals: No!’
During the post-survey press conference, Chief Economic Advisor Krishnamurthy Subramanian was surprisingly critical of rating agencies. He asserted that India’s sovereign ratings were not in consonance with its economic fundamentals and urged the rating agencies to be more transparent in its analysis. "… on both willingness to pay and ability to pay, India should have the highest rating and that is consistent with the large literature that highlights bias in sovereign ratings," he said.
This surprisingly strident tone from the government’s top economist seems to be a break from the past. Governments, and in particular Finance Ministers’ approach, in the past towards ratings agencies have veered from extreme caution to downright supplication. Finance Ministers did their best not to upset rating agencies and some even used to regularly hold meetings with them to showcase reform measures taken by them in the fond hope of getting favourable sovereign ratings.
The Survey finds it galling that the Indian economy, being the fifth largest in the world, has been rated in the lowest rung of investment grade. It says, “India has consistently been rated below expectation as compared to its performance on various parameters during the period 2000-20.”
It argues, quite persuasively, that India’s forex reserves are more than adequate to pay off the private sector’s short-term debt and also the entire stock of external debt, including that of the private sector’s. It also says that India’s "zero default" history is evidence of both its ability as well as willingness to repay its debts. The Survey further says, “In corporate finance parlance, therefore, India resembles a firm that has negative debt, whose probability of default is zero by definition.”
Checks and balances
The Survey also notes that past ratings changes have not reflected in other indicators such as Sensex returns, exchange rate and yields on government securities as the ratings do not reflect fundamentals. It then goes on to conclude, “India’s fiscal policy should be guided by considerations of growth and development rather than be restrained by biased and subjective sovereign credit ratings.”
This statement gives us a clue on why the government was critical of ratings agencies. In a year where economies world over were decimated by the coronavirus, governments have decided that massive spending programmes are the only way to get their economies running again.
Finance Minister Nirmala Sitharaman during the Budget speech clearly said that India was planning to return to the path of fiscal consolidation only in 2025-26, so till then the fiscal deficit is going to remain at an elevated level, certainly far above the rating agencies’ comfort level. What’s more the Budget also indicated the government’s massive borrowings programme to bridge the deficit as the scope for buoyant tax revenues or cutting expenditure remains limited in these pandemic times.
So the Economic Survey, in its rant against the rating agencies, was perhaps preparing the ground both for the markets as well these agencies, for the massive hike in fiscal deficit and the government’s borrowing programme. From a political angle, the ‘pre-emptive strike’ against ratings agencies could also be part of the government’s ‘Atmanirbhar Bharat’ or self-reliance agenda.
But going ahead it will be interesting to see how the government reacts if and when the ratings agencies decide to downgrade India’s sovereign ratings in future. For now the government can pat itself on the back for putting ratings agencies in their place.