Page 107 - ES 2020-21_Volume-1-2 [28-01-21]

90 Economic Survey 2020-21 Volume 1

Figure 4: India’s GDP Growth Annual (Per cent) (1990-2020)

Source: MoSPI and RBI

DOES INDIA’S SOVEREIGN CREDIT RATING REFLECT ITS
FUNDAMENTALS? NO!

3.5 There is a large academic literature that highlights bias and subjectivity in sovereign credit
ratings, especially against countries with lower ratings (see Box 2 for a select literature review).
Do the fundamentals that supposedly drive sovereign credit ratings rationalise this historical
anomaly of India’s low ratings? In this chapter, the Survey asks this important question and
answers a resounding No!

Box 2: Select Literature on Bias and Subjectivity in Sovereign Credit Ratings

Ferri, Liu, and Stiglitz (1999) suggested that CRAs aggravated the East Asian crisis by first failing
to predict its emergence and thereafter becoming excessively conservative. CRAs downgraded
East Asian crisis countries more than what would have been justified by these countries’ worsening
economic fundamentals. This adversely affected the supply of international capital to these countries.
Ferri, Liu, and Stiglitz (1999) also proposed an endogenous rationale for CRAs becoming excessively
conservative after making errors in predicting the crisis – that of recovering from the damage caused
by these errors and rebuilding their own reputation.
Reinhart (2002) found evidence of procyclicality in ratings through her study of 62 economies over
the period 1979-1999. She observed that sovereign credit ratings tend to be reactive, especially for
emerging market economies, with significantly higher probability of downgrade as well as higher
size of downgrade as compared to developed economies.
Kaminsky and Schmukler (2002) also found evidence of procyclicality of credit ratings and that rating
agencies may be contributing to financial market instability in emerging economies. They observed
that rating upgrades take place after market rallies while downgrades take place after downturns.
Further, they suggested that even “if rating agencies do not behave procyclically, their announcements
may still trigger market jitters because many institutional investors can hold only investment-grade
instruments. Downgrading (or upgrading) sovereign debt below (or above) investment grade may thus