My title is: Indian Economy| Global Credit Ratings

Global Credit Ratings

2019-11-25 | 5 minutes


Recently, Moody’s has reduced India’s outlook from stable to negative. Standard & Poor's (S&P), Moody's, and Fitch are the three main credit rating agencies. They are collectively referred to as “Big Three credit rating agencies”. Credit rating agencies assess and rate economic and business strategies of companies and financial governance of sovereign nations on a scale. They also rate assets such as bonds, debentures, commercial documents, deposits, and other debt initiatives by businesses or states.

Assessment by credit rating agencies

  • Basis of credit ratings: The assessments of these agencies are based on analysis of official and other non-official information and communication with government functionaries, leaders of businesses and economists.
  • Purpose: The purpose of ratings is to aid investors in making informed decisions. The higher ratings from the agencies also help companies or governments collect funding at a lower price.
  • Grounds of changes in ratings: The agencies either upgrade or downgrade assets on the grounds of performance, possibilities, or activities that are likely to have an effect on balance sheet of companies or fiscal condition of a sovereign government or a sub-sovereign organization. Ratings of sovereign governments by the agencies may also be downgraded on the grounds of political uncertainty. On the grounds of rising debt levels and political uncertainties, Standard & Poor's (S&P) reduced the best rating (AAA) of the US in August 2011.

Meaning of ratings and outlook by Moody’s

Long term ratings: Moody's grants long term ratings from Aaa to C. Whereas Aaa means the highest quality and lowest credit risk, C means the lowest quality and probability of recovery of capital or interest. Baa stands for mild credit risk.

Short-term ratings: Moody's assigns short-term ratings in terms of Prime-1, Prime-2 and Prime-3. These refer to best, high and acceptable ability to repay short term debt respectively.

Outlook: Stable outlook from Moody’s means that the rating will most likely remain at the same level and less likely be downgraded or upgraded. A positive outlook means that the credit rating may be increased in the medium to long term. A negative outlook means that the credit rating may be lowered in the medium to long term.

Recent change in India’s outlook from stable to negative

Two years ago, the Moody’s have upgraded India’s ratings to Baa2 from Baa3. But, the Moody’s says that India’s likelihood of consistent real GDP growth at or beyond 8 percent has significantly decreased in contrast to two years ago. It has lowered the outlook on the basis of growing risk that the growth would be significantly slower compared to the past and contribute to a steady increase in the debt burden from an already high level.

Impact on India of the negative outlook

  • Impact on Indian companies: While India’s sovereign credit rating continues to be at Baa2, India’s outlook by Moody’s has been reduced from stable to negative. This may affect companies that were looking to borrow abroad via bonds or loans because the creditors or banks offshore may be inclined to ask for refer interest rates due to weak outlook. The institutional lenders, like pension funds, endowment funds from foreign universities, and sovereign investment funds that control the assets of rich countries reorganize their investments when ratings are lowered.
  • Impact on government: The impact on government depends on its choice of borrowing. As India has not released a bond or collected money directly from the foreign market until now, the downgrade has a minimal effect. But, the private and state-owned companies that collect foreign currency funds feel effect almost exclusively. Though Indian government expressed its desire to issues a sovereign bond, RBI has been critical and concerned, and the government has not moved forward. Indian policymakers have not favored launch of sovereign bonds or direct borrowing from foreign markets.

Criticism of credit rating agencies

  • The bias of credit rating agencies:
    • The credit rating agencies quickly downgraded India’s credit ratings during the balance of payment crisis in 1991. This decreased the government's ability to raise funds internationally. India could not raise funds through public-sector oil companies or banks to purchase oil or finance imports.
    • After India conducted a nuclear test in Pokharan in 1998, the agencies quickly reacted and affected borrowings. Ignoring the credit rating agencies, the government and RBI then raised foreign currency through bonds offered by the SBI. Since then, Indian government did not interact much with credit rating agencies until 2004-05 and tried to alter perceptions built by these agencies.
  • Issues regarding the reliability of credit rating agencies:
    • 2008 global financial crisis: The banks and institutions rated highly by credit rating agencies failed during the global financial crisis of 2008, and the agencies faced criticism.
    • Probe by central investigation agencies: Last year, the agencies have awarded high ratings to funding by companies that were part of the Infrastructure Leasing & Financial Services Limited (IL&FS) group, which are being probed by central investigation agencies.
    • Revision of methodology of ratings: When the decline in India’s debt levels did not reflect in ratings of these agencies, the finance ministry had written to Moody's, and it raised doubts about its methodology and argued for its review. This was only a year prior to Moody's last upgrade to rating in 2017. As per the government, nations with greater levels of debt and poor fiscal policies have also achieved better ratings.

Indian government’s response to the recent change in outlook

In response to the recent change in outlook by Moody’s, the government asserted that India's fundamentals are strong. But certain macroeconomic indicators, such as inflation, are weak. They are reflected in low bond prices. The growth prospects in near and long terms are strong. The government in its response have disagreed with the evaluation of agency.