The Fitch of Poor Standards

The biggest sovereign credit rating agencies that assess nations' capacity to discharge their debt obligations - Standard and Poor's (S&P), Moody's and Fitch - can help make or unmake fortunes for nations. The rating they assign to a nation based on their perception of its poor standards and moods influences potential investors. It makes foreign borrowings dearer, hampers foreign investments and affects local currency rates and economic growth.

But how accurate are these ratings and do they really reflect a nation's economic strength? Many would argue that their assessments may be useful as indicators but are often not accurate on account of the inadequacies in their methodologies.

The rating agencies depend on a plethora of assessment matrices based on western models that are in many respects ill-suited to assess nations that follow different systems, often resulting in inchoate conclusions. For instance, India was herded by a major rating agency in the BBB- category along with Tunisia, Barbados, Croatia, Morocco, Iceland, Colombia, Azerbaijan and Panama, whose aggregate GDP in 2011 was not even 30% of India's.

Rating agencies have lent themselves to severe criticisms ranging from an Anglo-Saxon bias to manipulating ratings for building revenue. Many of them were exposed in the inquiries conducted after the subprime crisis and the testimonies of some of their erstwhile employees were damning.

The big three were hard put to explain their action of giving investment-grade rating to AIG and Lehman Brothers even when the two firms were teetering on the brink of imminent collapse. Particularly inexplicable was Moody's issuance of A2 rating (safe long-term investment grade) to Lehman Brothers minutes before it filed for bankruptcy. The criticism that followed was scathing.

It impelled Congressman Michael E Capuano, to assert before a US House Subcommittee in July 2011 that the 'credit rating agencies [had] failed spectacularly in the years leading up to the financial crisis' and their 'faulty ratings' had contributed 'significantly' to 'economic problems'.

Perhaps, the reasons for their failure may be embedded in the testimony of a senior vice-president of Moody's before the Financial Crisis Inquiry Commission in June 2010, that the anxiety of the analysts of the agency was not if their rating would go wrong, but if their rating would cost them a client and 'impair' their revenue.

The credulity of their assessments is further eroded as they often depend on outside analyses that are at times fundamentally flawed. India has received short shrift in their hands on account of such dependence.

For instance, in the comparative matrix on Worldwide Governance Indicators, 2011, World Bank and Doing Business Report, 2011, on political stability, India was ironically assigned -1.315 units in comparison to 0.098 for Tunisia, a country that became the springboard for the Arab spring.

And if that were not enough, for regulatory quality, India was placed last among the 10 countries in the BBB- category notwithstanding the fact that the Reserve Bank of India and the Securities and Exchange Board of India are amongst the best regulators in the world and the former, especially, had during the recent financial crisis earned the world's encomium for its regulatory excellence.

The consequence of the numerous flaws in their methodologies is that India has ended up being portrayed as a nation with a weak economy and a diminished capacity to discharge its debt liabilities. But does India deserve such low ratings?

In September 1990, S&P gave India BBB stable, the highest rating the agency has given the country. The last assessment was in April 2012, when it reaffirmed India's BBB- rating. Does it mean that during the intervening period, India's economy had become weaker?

In 2012, India became the third-largest economy in PPP terms, up from ninth rank in 1990. From 1992 to 2001, India's GDP doubled from $841.5 billion to $1.7 trillion, and grew faster in the next decade to $4.5 trillion, registering a rise of 151%. In comparison, during the latter period, Brazil grew by 72%, Russia by 86% and South Africa by 70%. India's per-capita GDP growth also nearly kept pace.

From 2002 through 2011, India's share in world GDP grew 50% - from 3.8% to 5.7% - compared to less than 1% for Brazil, less than 9% for Russia and -0.5% for South Africa. India's exports doubled from 1992 to 2001, to increase more than five times in the following decade. FDI during 2011-12 reached a new record of over $46 billion.

Perhaps the rating agencies fail to see the larger picture and assign disproportionate weightage to issues such as headline inflation and fiscal deficit, eclipsing the import of other positive indicators.

It is often incomprehensible to them why a nation should have an abiding commitment to inclusive growth and provide succour to the nearly 360 million people who live below the poverty line through several poverty alleviation and subsidy programmes when the country is grappling with fiscal deficit.

There are, however, indications that they have, of late, begun to better appreciate India's comparative strength as the state of other economies continues to make India look better. The hope is that they would stop missing the woods for the trees, stop underrating the world's second-fastest growing economy that is predicted to be the biggest global economy by around 2050.