Page 102 - ES 2020-21_Volume-1-2 [28-01-21]

Does India’s Sovereign Credit Rating reflect its fundamentals No! 85

total external debt (including that of the private sector) of US$ 556.2 bn as of September
2020. In corporate finance parlance, therefore, India resembles a firm that has negative
debt, whose probability of default is zero by definition. Despite this compelling statistic,
India is an inexplicable outlier in its ratings cohort. The Survey’s findings are consistent
with a large academic literature that highlights bias and subjectivity in sovereign credit
ratings, especially against countries with lower ratings.
As ratings do not capture India’s fundamentals, it comes as no surprise that past episodes
of sovereign credit rating changes for India have not had major adverse impact on select
indicators such as Sensex return, foreign exchange rate and yield on government securities.
Past episodes of rating changes have no or weak correlation with macroeconomic indicators.
India’s fiscal policy, therefore, must not remain beholden to a noisy/biased measure of
India’s fundamentals and should instead reflect Gurudev Rabindranath Thakur’s sentiment
of a mind without fear. Despite ratings not reflecting fundamentals, noisy, opaque and
biased credit ratings damage FPI flows. It is therefore imperative that countries engage
with CRAs to make the case that their methodology must be corrected to reflect economies’
ability and willingness to pay their external obligations. Moreover, the pro-cyclical
nature of credit ratings and its potential adverse impact on economies, especially low-
rated developing economies must be expeditiously addressed. India has already raised
the issue of pro-cyclicality of credit ratings in G20. In response, the Financial Stability
Board (FSB) is now focusing on assessing the pro-cyclicality of credit rating downgrades.

THE BIAS AGAINST EMERGING GIANTS IN SOVEREIGN CREDIT
RATINGS

3.1. Never in history has the fifth largest economy in the world been rated a BBB-! Since 1994,
the only times that the sovereign credit ratings of the fifth largest economy in current US$ terms
has precipitously declined, has been when emerging giants China and India have come to occupy
the position. Figure 1 shows that the sovereign credit rating of the fifth largest economy (current
US$) by two credit ratings agencies (CRAs) declined steeply in 2005 following China’s entry into
the top five economies. Similarly, the sovereign credit rating of the fifth largest economy (current
US$) by two CRAs declined steeply in 2019 following India’s entry into the top five economies.

Figure 1: Sovereign Credit Rating of Fifth Largest Economy (Current US $)

Sovereign Credit Rating S&P/Moody's

Source: Bloomberg and World Bank