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Credit Rating Agencies – The Real non- tariff barrier
Context:
Sovereign credit ratings significantly influence a nation’s access to and cost of borrowing in international markets. The ratings assigned by the “Big Three” credit rating agencies (CRAs) — S&P, Moody’s, and Fitch — play a pivotal role in shaping global perceptions of a country’s economic stability. However, the methodologies and biases underlying these ratings have come under scrutiny for being outdated and inconsistent with current global economic realities.
About the Sovereign Rating Entities:
- The Big Three CRAs dominate the sovereign credit rating ecosystem. They evaluate a country’s creditworthiness, which determines its ability to meet debt obligations.
- These ratings are critical for investors and influence a country’s financial credibility on the global stage. However, their methodologies and decisions are often opaque, raising questions about their validity and impartiality.
Benefits of Sovereign Ratings:
- Access to International Markets: Sovereign ratings enable countries to secure loans and investments by providing a benchmark for assessing credit risk.
- Cost of Borrowing: Higher ratings lower borrowing costs, while downgrades increase interest rates for loans.
- Investor Confidence: Ratings offer investors an insight into the risk associated with a country’s bonds and financial instruments.
Issues with the Rating Agencies:
- Methodologies Questionable:
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- Pro-Cyclicality: CRAs exhibit a tendency to upgrade ratings during economic booms and downgrade them during crises, lacking foresight & exacerbating financial instability.For instance, prior to the 2008 financial crisis, most sovereign ratings were upgraded despite underlying vulnerabilities.
- Opaque Models: CRAs rely on undisclosed models that are not subject to academic or professional scrutiny. This lack of transparency undermines their credibility.
- Arbitrary Metrics: The use of per capita income as a key metric often disadvantages emerging economies like India, despite their robust macroeconomic fundamentals.
- Qualitative Overlays: Ratings incorporate subjective surveys and indices, such as the discontinued World Bank Ease of Doing Business index, which are prone to bias.
- The Bias:
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- Subjective Assessments: CRAs rely on indices and surveys that often lack transparency and auditability, leading to biased conclusions.
- Political Stability: Western political events are assessed leniently, whereas similar occurrences in the Global South would likely result in negative ratings.
- Qualitative Overlays: Ratings often reinforce stereotypes about governance and institutional strength in emerging markets.
- Western Hegemony: By setting higher benchmarks for emerging economies, CRAs perpetuate a global financial order favoring the West.
The Case of Greece and India: Loopholes in Rating Agencies
Greece:
- Between 1994 and 2003, Greece’s rating was upgraded by six notches, reaching A+.
- Post-2008, Greece defaulted on IMF loans and faced severe economic instability. Its rating plummeted to C.
- Despite defaults, Greece’s rating bounced back to BBB- by 2023, largely benefiting from Eurozone membership.
India:
- India’s rating was upgraded to BBB- in 2006-07 and has remained stagnant despite robust economic performance.
- India has never defaulted and last approached the IMF in 1991, repaying its debt early.
- Post-COVID, India’s GDP grew by 7.5%, outperforming Greece’s 5.6%.
- India’s government debt-to-GDP ratio stands at 83%, compared to Greece’s staggering 160%.
Bias Against India:
- Despite India’s economic resilience and macroeconomic stability, its rating outlook has been slower to improve compared to Greece.
- MSCI’s emerging markets index ranks India as the top destination, yet CRAs continue to undervalue India’s economic potential.
Negative Impacts of Biased Rating Agencies:
- Higher Borrowing Costs: Emerging economies face increased interest rates due to lower ratings, diverting funds from developmental projects.
- Global Perception: Biased ratings diminish investor confidence in the Global South.
- Economic Inequality: Favorable ratings for Western nations perpetuate economic disparities on a global scale.
Reasons Behind CRA Bias:
- Preservation of Western Dominance: CRAs reinforce the financial hegemony of developed nations by disadvantaged emerging economies.
- Inadequate Representation: Emerging economies have limited influence on the methodologies and frameworks used by CRAs.
- Reliance on Outdated Models: Metrics favour developed economies, ignoring the dynamic and resilient nature of emerging markets.
Way Forward to Improve CRA Credibility:
- Transparency: CRAs must disclose their methodologies and undergo independent audits.
- Inclusion of PPP Metrics: Incorporating purchasing power parity-based GDP metrics would offer a fairer assessment.
- Objective Frameworks: Ratings should focus on empirical data rather than qualitative overlays.
- Global Representation: Developing countries should have a say in defining rating methodologies.
- Alternative Institutions: The Global South should consider establishing independent rating agencies to challenge the current regime.
