Remote controls are identified as technical devices which are used for various purposes ranging from the launching of space-ships to the monitoring of toy cars. But of late, these devices are being used to direct policies for nation states which are formally sovereign.
We speak here of the powerful lobby of international credit rating agencies like Standard and Poor's (S&P), which has just delivered its sermon that India is no longer an “investment grade” destination for international capital. Downgrading India to BBB minus comes with negative listings for 10 major companies (including those in software) and 10 top ranking banks (including public sector giants like the State Bank of India).
The reasons behind the downgrade, as provided by the Singapore-based credit analyst of S&P, Takahira Ogawa, include the country's widening fiscal deficit and external accounts, the drop in its GDP growth rate and the uncertain political climate of the country. For the country to “stabilise,” as put specifically by Mr. Ogawa, there is a need “… to reduce fiscal deficits, and improve investment climate … (with) an efficient use of subsidies on fuel and fertilizers … (also)… an early implementation of the goods and service tax”. He warns that there exists a “one-in-three” possibility of a further downgrade of India's credit rating to “junk bond” status if conditions do not improve.
Sharp reactions
The news about the downgrade and the related advice have led to sharp reactions from the government and the media, the former trying to chart out a future course in policies, in a direction which probably was already on the agenda. For the capital market, the downgrade brought in moderate fluctuations and a 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 up to.
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 usually ratings are based on “analyst-driven” models, with S&P assigning 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 the basis of a subjective judgment. The pattern is similar to what concerns an average investor in an uncertain market, whose decisions are, in part, based on subjective assessments.
Judgments by 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 “stability” in the borrowing country. Of course, in such prescriptions the assessment or judgment relating to the state of the economy plays a vital part.
The prevalent attitude on the part of policymakers in developing borrowers to accept uncritically the rating as well as the diagnosis offered by agencies like S&P warrants further analysis. We recall that past assessments of country risk by these agencies often failed to predict an impending crisis, as for example, in 1967 for some Asian countries, in 1964 for Mexico. Rather, the announcement of a downgrade brought in, as an ex-post event, a banking and financial crisis. Again, the judgment of the rating agencies cannot 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.
These failings also open up a debate as to why S&P decided to downgrade India, in particular, below investment grade with a debt/GDP ratio at 67 per cent, export growth at above 40 per cent, non-financial services rising at 17.1 per cent, official foreign exchange reserves rising by $5.7 billion over the six months ending September 2011, and with the stock adequate to finance six months of imports. The rise in the current account deficit to 3.6 per cent of GDP during April-September 2011 was preceded by a 3.8 per cent figure over the corresponding months in 2010. Net capital inflows, at $12.3 billion for FDI, record a smart performance as compared to $7.04 billion 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 $23.7 billion to $1.34 billion between April-September 2010 and 2011. After all, a drop in short term speculative 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 is poverty and unemployment in the country which, if not worsening, has certainly been continuing. Obviously, such issues of the real economy have little to do with the financial sphere which would concern the credit rating agencies.
Implications
From what we tried to document above, a downgrade in credit rating by an agency like S&P for a borrowing economy like India has several implications.
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 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 includes subsidies. Also, fiscal restraint may not be the answer to revamp a slowing down of growth in the economy.
Second, most of the indicators relating to India, as pointed out above, do not justify S&P's decision to blacklist the country, thus sending a message to not only global financial markets but also policymakers 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 the part of S&P to push a package, not only with a biased credit rating but also with specific instructions relating to the “right” tax-subsidy and fiscal balance. After all, a sovereign nation with a democratically elected parliamentary system cannot afford to follow policies dictated by such financial agencies.
The pattern reminds one of India's conditional borrowings from the International Monetary Fund, 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 advice from self-appointed financial mediators like S&P who are trying to use their remote-control apparatus on us while having no legitimacy or track record to justify their actions.
(Sunanda Sen retired as Professor of Economics, Jawaharlal Nehru University)
