Does Sovereign Credit Rating reflect the state of India’s Economy?

The ‘Big Three’ have further downgraded India’s Sovereign Credit Rating and the government is protesting ‘injustice’. Among the ‘Big Three’, Moody’s used to have an optimistic approach towards India in the past years. However, they too downgraded India to the lowest Investment Grade possible. The agency downgraded India to the lowest rating for the first time in twenty-two years. Although, the government is trying to convince itself and the masses, that the rating is biased, there is never smoke without fire.

At the same time, looking at the history of discrimination of these agencies against developing nations, can the ratings be completely believed? Should the pandemic be blamed for weakening the economy in every aspect?

What is Sovereign Credit Rating and Who are the Big Three?

The ability of the borrower to pay back the debt within a stipulated time leads to higher credit rating, while the inability of the same results in a lower credit rating. When, this is applied to governments and their ability to pay back external debt, it becomes ‘Sovereign Credit Rating’.

Credit rating is essentially done by different investment agencies who specialize in it. The Big Three constitute 95% of this industry, making the industry highly concentrated and vulnerable to bias.
The agencies which comprise the Big Three are: Moody’s Investor Services; Standard and Poor’s; Fitch Group.

Before proceeding further, it’s important to understand the credit rating system adopted by these firms and India’s rating. Credit rating can be divided into two essential grades, namely- Investment Grade and Speculative Grade.
Investment Grade: Aaa > Aa1 > Aa3 > A1 > A2 > A3 > Baa1 > Baa2 > Baa3
Speculative Grade: Ba1 > Ba2 > Ba3 > B1 > B2 > B3 > Caa1 > Caa2 > Caa3 > Ca > D

Evidently, Aaa is the best rating and India has been given the lowest Investment grade rating- Baa3. Before blaming the agencies, let’s focus on the flaws in the economy of the country.

Why was India rated Baa3?

There are many factors that can be attributed to it, however, weak implementation in every field of reform has always been an issue.

1.GDP growth
Even decades after gaining Independence, India’s economy isn’t strong. However the constant growth in GDP until 2017 was the reason for Moody’s optimism towards India’s economy. The main reason for that growth was the policy of ‘Liberalization, Privatization and Globalization’, implemented in 1991. It saved India’s economy at that period of time. However, times have changed and so has India’s economy. India is in need of reforms and diversity.
Moreover, the GDP growth of India has been declining since 2017; from 8.3% in the fiscal year 2016-2017 to 4.2% in 2019-2020. Since the decline has been over a span of four years, the pandemic cannot be blamed for it.

2. Non Performing Assets (NPAs)
The rising stress in India’s financial sector because of NPAs has also contributed in a low rating. The country is seriously affected by this problem. Due to lack of proper monitoring and follow-up, many of the Public sector banks in India are turning into NPAs. This affects the recycling of funds, leading to an adverse effect on the deployment of credit. Public confidence on banks also lowers due to increased incidence of Non Performing Assets.

3. Fiscal position of the Government
India’s fiscal stimulus package falls way short of the global standards. The overestimation of revenue and underestimation of expenditure has led to low economic growth over a sustainable period of time. India might be recovering from the effects of the pandemic, however, the recovery has been driven by the urban sector.
The government needs to focus on a sustainable recovery and target the informal sector equally.

4. Execution of Economic Reforms
The new laws and reforms being introduced are not well thought out with the stakeholders. As a result, the implementation of tese reforms is poor.
The reforms have been largely focused on big firms and employers rather than the employees. There is no employment protection due to the provision of ‘flexibility in hiring and firing’ to the employers. This has, in turn lowered the confidence of the working sector on the government.
the economic reforms being introduced are not even doing the bare minimum, to sustain the weak economy of the nation.

Why are the BRICS nations protesting against the Sovereign Credit Rating?

India and the other growing economies which constitute the BRICS are of the opinion that the rating is flawed and biased towards developed nations. This can’t be denied. This is a rare platform where China and India are on the same page.

Since most of the credit rating industry is dominated by three giant agencies, bias is inevitable. There have been complaints against the agencies because of the fact that they can be controlled and coerced by powerful nations.
The Big Three have many-a-times been accused of being discriminatory towards developing nations. However, according to leading economists, the grounds on which India was downgraded was viable, at least to a certain extent. The pandemic has only worsened the already weak economy.

The Economic survey of India(ESI) has called the ratings ‘noisy, opaque and, biased’. ESI is of the opinion that the rating does not capture the fundamentals of the Indian economy. The Survey argues that the rating is completely flawed because of the fact that India has never had a sovereign default history. As a counter measure, the government has set up a different Credit Rating Agency for the country, hoping to oppose the effects of the ratings on FPI flows.

Impact of Baa3 rating on India

As mentioned earlier, India has the lowest investment grade rating, and cannot afford to downgrade more. The rating has a direct impact on the flow of foreign capital to the country. A lower rating means lower interest of international agencies towards providing loans to India. It also results in higher interest rates, leading to more stress on the economy.
Since these ratings give an investor insight into the risk associated with investing in a nation, funding from international bond markets maybe hindered. This further hinders the level of progress of a nation and the trust on the nation in the international market.

The Path Ahead

The government should consider focusing on the structural challenges faced by the country today. The main areas of weakness being decrepit infrastructure, rigidities in labor, land and product markets and the rising risks in the financial sector.
Strengthening and government investment in certain sectors such as healthcare is needed; while slow removal of government funding to certain PSUs is also imperative for growth.
Attention should also be given to the debt to GDP ratio. At present, the ratio is 68.67%. Although, the government argues that it is improving, the ratio is still very high. This shows investors that there is higher risk of default, by the government. Persistent efforts need to be made over time with sustainable economic development in mind. 

Since it is true that India being the fifth largest economy, should not have been given such a low rating, the agencies also need to become transparent and inclusive.

Instead of blaming the ratings for being flawed and opaque, India and the other developing nations need to work with the credit rating agencies to reform the methods involved in credit rating. instead of blaming the ratings for being flawed and opaque.