Central Idea

India’s Chief Economic Adviser, V Anantha Nageswaran, emphasizes the need for reform in the sovereign credit rating process.
The aim is to accurately reflect the default risk of developing economies and reduce their funding costs.

What are Sovereign Credit Ratings?

A sovereign credit rating is a measure of a country’s creditworthiness, or its ability to meet its financial obligations.
It is an assessment of the credit risk associated with a country’s bonds or other debt securities.
The rating is assigned by credit rating agencies such as Standard & Poor’s, Moody’s, and Fitch Ratings.
S&P and Fitch rate India ‘BBB-‘ and Moody’s ‘Baa3’, all indicative of the lowest possible investment grade, but with a stable outlook.

Current Rating: India is at the lowest possible investment grade but is seeking an upgrade due to improved economic metrics post-pandemic.
Government Engagement: Continuous efforts are being made to engage with global credit rating agencies for an improved rating.

Opacity and Impact: CEA points out the opaqueness in rating methodologies and the difficulty in quantifying the impact of qualitative factors.
Bandwagon Effects and Biases: The significant presence of qualitative factors leads to cognitive biases and concerns about the credibility of ratings.

Meetings with Top Agencies: Finance ministry officials have met with representatives from Fitch Ratings, Moody’s Investors Service, and S&P Global Ratings.
Current Ratings: While S&P and Fitch rate India at BBB, Moody’s rates it at Baa3 with a stable outlook.

Typical Parameters: Agencies consider factors like growth rate, inflation, government debt, and political stability.
Qualitative Component: Over half the ratings are determined by qualitative factors, often non-transparent and perception-based.
Dominance in Ratings: Institutional Quality, often measured by World Bank’s Worldwide Governance Indicators (WGIs), is a significant determinant for developing economies.
Issues with WGIs: These metrics are non-transparent, perception-based, and may not represent a sovereign’s willingness to pay.

Need for Transparency: Sovereigns are expected to be transparent; similarly, rating agencies should make their processes clear and avoid untenable judgments.
Potential Benefits: Enhanced transparency could lead to more reliance on hard data and possible credit rating upgrades for many sovereigns.
Access to Private Capital: Improved ratings can help developing countries access private capital crucial for addressing global challenges like climate change.
India’s Export Targets: With initiatives like production-linked incentives and Make in India, India aims for a $2 trillion export target by 2030.

Advocacy for Change: Nageswaran’s comments highlight the need for a more equitable and transparent sovereign credit rating process.
Broader Implications: Such reforms could not only benefit developing economies like India by reducing funding costs but also contribute to a more accurate and fair global financial system.