Page 120 - ES 2020-21_Volume-1-2 [28-01-21]

Does India’s Sovereign Credit Rating reflect its fundamentals No! 103

Box 6: Methodology for Examining Effect of Changes in
India’s Sovereign Credit Ratings on Select Indicators

We examine the effect of changes in India’s sovereign credit ratings during 1998-2018 on select
indicators – stock market return, foreign exchange rate, yield on government securities and foreign
portfolio investment flows.
We use Sensex return as change in stock market indicator; changes in INR/USD exchange rate as the
foreign exchange rate indicator; 5 Year G-Sec yield, 10 Year G-Sec yield and Spread (RHS) as the
government securities indicators; and FPI Equity and FPI Debt flows as FPI indicators. Sensex return
and changes in exchange rate (INR/USD), G-Sec yields and spread (difference between 10 year and
5 year yield) and FPI (Equity and Debt) are defined as change over previous period.

The potential effects of credit ratings changes are examined over three time periods:

(i) Short Term: This analysis is based on the occurrence of a ratings change (downgrade/upgrade)
on day “T=0”, and examines the average change in select indicators during a period of ten working
days preceding and succeeding the event. In other words, assuming that a credit ratings change takes
place on day “T”, we examine the average change in indicators during “T-10” and “T+10” days.
(ii) Medium Term: This analysis is based on the occurrence of a ratings change (downgrade/

upgrade) in month “T=0”, and examines the average change in select indicators during a period of
six months preceding and succeeding the event. In other words, assuming that a credit ratings change
takes place in month “T”, this section examines the average change in indicators during “T-6” and
“T+6” months.
(iii) Long Term: This analysis is based on the occurrence of a ratings change (downgrade/upgrade)
in year “T=0”, and examines the average change in select indicators during a period of one year
preceding and succeeding the event. In other words, assuming that a credit ratings change takes place
in year “T”, this section examines the average change in indicators during “T-1” and “T+1” years.

We also examine the effect of India’s threshold sovereign credit ratings changes on select indicators.
Threshold changes are defined as sovereign rating changes from investment grade to speculative
grade and vice versa.

Daily, monthly and annual data for Sensex return is available for the entire period of analysis (1998-
2018). Daily exchange rate data is available from August 1998 onwards while monthly and annual
exchange rate data is available for the entire period 1998-2018. Monthly data for G-Sec yields (5 year
and 10 year) and annual data for FPI Equity and FPI Debt (` Crore) is available for the entire period
of analysis (1998-2018).

Short-Term Effect of India’s Sovereign Credit Rating Downgrades

3.36 Figure 33 shows the correlations between a credit ratings downgrade and Sensex return
as well as exchange rate (INR/USD), averaged across downgrade episodes from 1998-2018. It
may be seen in Figure 33 (i), that during the rating downgrade, Sensex return, on average, fell by