Remote controls are identified as technical devices which are used for various purposes ranging from launching of space-ships to monitoring of toy cars. But of late these devices seem to have been operational in directing policies for nation states which are formally sovereign. We speak here of the powerful lobby of international credit ratings like Standards and Poor(S&P) which has just delivered its sermon that India is no longer a desired destination for international capital. Downgrading India to BBB minus ( which is the lowest investment grade) comes with negative listings for 10 major companies ( including the high-tech softwares) and 10 top ranking banks ( including the public sector giants like the State Bank of India).
The reasoning behind the downgrade, as provided by the the Singapore based credit analyst of S&P, Takahira Ogawa, include the country’s widening fiscal deficits and external accounts, the drop in its GDP growth rate and the uncertain political climate of the country. For the country to ‘stabilize’, as put specifically by Ogawa, there is a need “…to reduce fiscal deficits, and improve investment climate…(with) an efficient use of subsidies on fuel and ferlilisers … (also)… an early implementation of the goods and service tax”. He warns that there exists an ‘one-in-three’ possibility of further downgrade of credit reting to a ‘junk bond’ status if conditions do not improve!
The news about the downgrade and the related advices have led to sharp reactions from the government and the media, the former trying to chart out the future course in policies, in a direction which probably was already in the agenda. For the capital market , the downgrade brought in moderate fluctuations and drop in stock prices in the Mumbai stock markets. It may, however remain a strategic move on part of the market to wait, see and then react to what the policymakers in the government are upto.
Since the sermon from the remote-sensing agency regarding a negative investment climate in the economy carries a lot of weight , both for the government and the capital market, it makes sense to ask a few questions relating to the context of these credit ratings. A look at the S&P website tells us that there usually are the “ analyst-driven” models to do these ratings where S&P assigns an analyst, often in conjunction with specialists, to work on the ratings which are “paid for,…either from the issuers (of borrowing instruments) or from subscribers ( the investors) who receive published ratings”. Also while dealing with quantitative data relating to the capital importing country, weight is placed on the political climate in the country an assessment of which is made by the agency on basis of a subjective judgement. The pattern is similar to what concerns an average investor in an uncertain market, with decisions are in part based on subjective assessments.
Judgements by credit rating agencies like S&P are subject to the following pre-suppositions in adjudging the credit ratings of countries: First that the rating agencies are in a position to judge ( or even forecast) the state of political stability in these countries and weigh their significance for the credit transactions; second that their own judgment ( usually based on the mainstream doctrines) on economic policies will bring back what they consider as ‘stability’ in the borrowing country. Of course in such prescriptions the assessment or judgement relating to the state of the economy plays a vital part.
The prevalent attitude on part of policy makers in developing borrowers to uncritically accept the rating as well as the diagnosis offered by agencies like the S&P warrant further analysis. We recall that past assessments of country risk by these agencies often failed to predict an impending crisis, as for example, in 1997 for some Asian countries, in 1994 for Mexico. Rather the announcement of a downgrade brought in, as an ex post event, banking and financial crisis . Again, the judgement of the rating agencies can not go unquestioned when one recalls the successive debt crunches of countries in southern Europe by end 2009 most of which were cleared with AAA or AA ratings in 2006.
Aspects as above also open up a debate as to why S&P decided to downgrade India as lowest investment grade with a debt/GDP ratio at 67%,export growth at above 40%, non-financial services rising at 17.1%, official reserves rising by $5.7bn over six months ending September 2011 , and with the stock adequate to finance six months of imports. The rise in current account deficit to 3.6% of GDP during April-September 2011 was preceeded by a 3.8% figure over the corresponding months in 2010-. Net capital inflows, at $12.3bn for FDI records a smart performance as compared to $7.04bn over the corresponding months in 2010. What possibly is not a matter which should cause worries is the drop in net portfolio capital which has fallen from $23.7bn to $1.34bn between April-September 2010 and 2011. After all a drop in short term speculatory finance to a country may not have much to do with a country’s long term investment potential. However, what the S&P rating criteria will never be concerned with relates to poverty and unemployment in the economy which ,if not worsening, has been continuing. Obviously such issues of the real economy has little to do with the financial sphere which would concern the credit rating agencies.
From what we tried to document above, a downgrade in credit rating by an agency like the S&P for a borrowing economy like India has implications which are more than one. First, an uncritical acceptance of the prescriptions generated by the agency may not necessarily serve the interests of the domestic economy. In particular, cuts in subsidies, especially on fuel would add to inflation by raising transport and other costs. It may be recalled that in recent years budgetary provisions for expenditure show steep increases in expenditure on liabilities to meet interest payments on marketised loans by the government. This often has to be met by cutting down social expenditure which include subsidies. Also fiscal restraint may not be the answer to revamp a slowing down of growth in the economy. Second, most of indicators relating to India , as pointed out above, do not justify the act by S&P , in blacklisting the country , thus sending a message not only to the global financial market but also the policy makers in the country. The specific mention of the ‘desired’ fiscal is adequately indicative of the latter. In our judgment , it is politically as well as ethically wrong , on part of S&P to throw the package, not only with a biased credit rating but also with the specific instructions relating to ‘right’ tax-subsidy and fiscal balance. After all a sovereign nation with a democratically elected parliamentary system can not afford to follow policies dictated by such financial agencies as the S&P. The pattern reminds of India’s conditional borrowings from the IMF which at least had more legitimacy as an international financial institution. Also India finally ended the arrangement under public pressure from within.
Let us hope the country defies the threats and ignores the advices from a self-appointed financial mediator like the S&P which is seeking its remote-control apparatus on us while having no legitimacy or track record to justify its actions.
Prof. Sunanda Sen is Former Professor of Economics, JNU
A version of this article was published in The Hindu