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Why has the Indian government criticised the methodologies of global credit rating agencies?

Context- On Wednesday, a document named ‘Re-examining Narratives: A Collection of Essays’ was published by the Finance Ministry. According to Chief Economic Advisor V Anantha Nageswaran, this document is an effort to showcase different viewpoints on various aspects of economic policy that could significantly influence India’s future growth and development objectives.

The initial essay out of the five in the document criticizes what the government terms as the ‘non-transparent methods used by credit rating agencies to determine sovereign ratings’. The essay aims to highlight problems with the approach taken by the three leading global credit rating agencies. It also demonstrates, using the Finance Ministry’s calculations, how these shortcomings negatively impact India.

Why do sovereign ratings matter?

  • Sovereign ratings are essentially assessments of a government’s creditworthiness. They serve as indicators for global investors about a government’s capacity and intent to repay debt.
  • Similar to how an individual’s credit rating influences their eligibility for a loan and the interest rate they receive, sovereign ratings impact a country’s borrowing ability from international investors.
  • In the same way that an individual or corporate borrower with a proven track record of loan repayment (demonstrating willingness to repay) and significant assets or income streams (indicating ability to repay) can secure a new loan (for a car, house, or factory) at a lower interest rate than someone without a credit history or guaranteed income streams or assets, governments with lower sovereign ratings face higher interest rates when they borrow.
  • Sovereign ratings are important not only for the government but also for all businesses in that country. This is because the government is viewed as the most secure entity in a country.
  • If a country’s government has a low sovereign rating, the businesses in that country end up paying even higher interest rates when they borrow from international investors.
  • Most developing countries, like India, while abundant in labor resources or land or mineral resources, are capital deficient (lack available money for use). Without financial resources, developing countries find it challenging to optimally utilize their natural assets.
  • A poor sovereign rating can hinder these countries’ ability to borrow money from wealthy investors, just as a good rating can facilitate increased productivity and poverty reduction.

Which are the main rating agencies?

  • Sovereign credit ratings have a history that goes back even before the establishment of the Bretton Woods institutions, namely, the World Bank and the International Monetary Fund. The three primary credit rating agencies recognized worldwide are Moody’s, Standard & Poor’s, and Fitch.
  • Moody’s, the oldest among them, was founded in 1900 and began issuing its inaugural sovereign ratings just prior to the onset of World War I. In the 1920s, Poor’s Publishing and Standard Statistics, which would later become S&P, initiated the rating of government bonds.
  • While the US and European nations have generally maintained a commendable record, their ratings have been influenced by global incidents. For example, an IMF research paper notes that during the 1930s Depression, there was a surge in sovereign defaults, leading to a downgrade in most ratings.
  • By 1939, all European sovereigns, with the exception of the UK, were classified under the speculative grade.

What is the government’s criticism?

The Finance Ministry has identified three primary concerns with the methodologies employed by rating agencies:

  1. They are deemed opaque and seemingly disadvantageous to developing economies. For instance, the Fitch document indicates that the agency prefers high levels of foreign ownership in the banking sector and views public-owned banks as susceptible to political interference. The government contends that such an evaluation discriminates against developing countries where the banking sector is predominantly public. It also overlooks the welfare and development roles that public sector banks play in a developing country, including promoting financial inclusion.
  2. The experts typically consulted for rating assessments are chosen in a non-transparent manner, adding another layer of opacity to an already complex methodology.
  3. The rating agencies do not clearly communicate the assigned weights for each considered parameter. While Fitch does provide some numerical weights for each parameter, they clarify that these weights are merely illustrative.
  • The Finance Ministry’s understanding of how Fitch assesses sovereign risk involves four main pillars, each with a specific weight. Each pillar has sub-components, again with individual weights.
  • However, each vertical also includes “Qualitative Overlay” variables. The main points of dispute are the use of the composite governance indicator (which has a weight of 21.4) based solely on the World Bank’s Worldwide Governance Indicators (WGI), and the use of Qualitative Overlay, which implies a subjective assessment.
  • The WGI uses various indices and reports to evaluate aspects of a country not captured by hard economic data, including freedom of expression, media freedom, rule of law, corruption, and quality of regulation. The government argues that there is an over-reliance on such subjective evaluations.
  • According to the government’s calculations, the influence of the composite governance indicator and perceived institutional strength outweighs the collective influence of all other macroeconomic fundamentals when it comes to the chances of earning India and other developing economies an upgrade.
  • This implies that to earn a credit rating upgrade, developing economies need to show progress along arbitrary indicators, which are also criticized for being constructed from a set of several one-size-fits-all perception-based surveys.

Conclusion- In conclusion, the Finance Ministry has raised significant concerns about the methodologies used by global credit rating agencies. The government argues that these methods are opaque, non-transparent, and disadvantageous to developing economies like India. The subjective assessments and the over-reliance on composite governance indicators are seen as major issues.

The government advocates for a more transparent, equitable, and objective approach to credit rating that takes into account the unique circumstances and developmental roles of public sector institutions in emerging economies.

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