Context

The prejudice and bias by the credit rating agencies (CRA) is affecting India’s credit rating, calling for a reassessment by credit rating agencies.

Enron Scandal

• Background: In 2001, Enron Corporation, a US company, filed for bankruptcy. This sent shockwaves through America as it exposed widespread accounting and auditing fraud by companies.
  • The Enron scandal is considered the biggest corporate fraud in US history, leading to numerous accounting and auditing reforms.
• Role of Credit Rating Agencies:
  • Dubious Work: The dubious work of CRA allowed the Enron fraud to remain hidden.
  • Promoting Investment: These agencies kept promoting investment in Enron while the company engaged in massive accounting fraud.
  • Hindering Development: The same Credit Rating Agencies are now hindering India’s development.

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What are Credit Rating Agencies?

• Assessing Financial Health: They assess the financial health of companies and countries.
  • They assign ratings like AAA, AA, A, BBB, etc. based on factors such as profits, loans, and future projections.
• Rating Implications:  Higher ratings indicate stronger financial stability and a lower risk of default. These ratings influence investors’ decisions to buy bonds or lend money.

Factors Considered by Credit Rating Agencies Agencies for Countries

• Per Capita Income
• GDP Growth
• Rate of Inflation
• External Debt

Significance of Credit Ratings – Country Examples

• Somalia: It has a very low credit rating due to civil war, unstable government, and poor economic conditions. Lenders are hesitant to give loans to Somalia, and if they do, the interest rates are very high.
• USA:  The USA has a AAA credit rating due to its strong economy, stable government, and robust financial system. Lenders are eager to lend to the USA at very low interest rates.

India’s Challenges with Credit Rating Agencies

• Hindering Development: For the past 20 years, credit rating agencies have been causing harm to India and damaging its reputation.
• Stuck in BBB: India has been stuck in the BBB rating category for many years.
• Lower Ratings: Countries with weaker economies than India have been given better ratings than India. Ex-Peru, Kazakhstan

How India is Being Harmed?

• Need for Loans: As a developing country, India needs loans for infrastructure development.
• Domestic Capital Raised: The Indian government has already raised capital from domestic sources, so it needs debt from foreign institutions.
• Higher Interest Rates:  With India’s BBB rating, it can get investment but at higher interest rates.

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The Risk of Rating Downgrades

• Rise in Bond Yield: If India issues a bond and an institute buys it, but India’s credit rating is downgraded, the bond yield will increase.
• Future Bond Issues: In the future, if India needs to issue any bonds, it will have to raise capital at higher bond yields.
• Economic Impact: This extra burden will directly impact the Indian economy.

India’s External Debt and Private Companies

• India’s external debt to GDP ratio is approximately 18%: Indicating that Indian private companies are mostly using external debt
• Higher Interest Loans to Companies: Many Indian companies, such as TCS, have an A rating. 
  • These companies could easily get loans at lower interest rates but they have to pay more because a company’s loan is based on the country’s rating.
  • This is one reason for low capital expenditure in India.

India’s Finance Ministry Report and Economic Indicators

• Ministry Report: In December 2023, India’s Finance Ministry released a report questioning the biased rankings of world rating agencies towards India.
• Deserve A rating: Considering all indicators of the Indian economy, it stated that India should have been in the A rating category long ago.
• Strong Indicators: India is the 5th largest economy in the world, has never defaulted, has one of the fastest growth rates, and inflation is in the range 4-5%.

Impact on Developing and African Countries

• Developing Countries: Many developing countries are also victims of biased credit rating agencies.
  • A UN report confirms that these countries cannot raise capital for economic development due to low ratings.
• African Countries: African and poor countries are particularly affected by the biased ratings. Without investment, the socio-economic development of these countries remains very backward.

Market Capture and Monopoly of Rating Agencies

• Market Share:  According to the UN report, Fitch, Moody’s, and S&P have captured 92% of  the global market, which does not allow fair competition.
• US-Based Agencies: This monopoly allows them to provide ratings that benefit Western nations.
• Low Ratings: Developing countries ratings are kept in the low category

Criticism of Rating Methodology

• Quantitative Parameters: Out of Moody’s 18 parameters, only 5 are quantitative (based on factual numbers).
• Qualitative Parameters: The remaining 13 parameters are qualitative, based on the subjective opinions of experts who are mostly from Western countries. There are no objective criteria for selecting these experts.

Rating Shopping and Conflict of Interest

• Rating Shopping: Studies have proven the existence of rating shopping, where false ratings are obtained by paying money.
• Fines Imposed: Heavy fines have been imposed on agencies for this practice.
• Conflict of Interest: There is a conflict of interest because the clients of these agencies are mostly the companies they rate.

Failure to Anticipate Crises

• Purpose: Credit rating agencies were created to maintain financial stability in the world.
• Exposure: However, whenever major crises have occurred, these agencies have been exposed.
• Failure to Predict: They failed to anticipate crises and, on the contrary, gave good ratings to financially unviable companies.
  • Lehman Brothers Crisis in 2008, triggered the worst financial crisis.

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India’s Way Forward

• Global Consensus: India should build consensus with the Global South for a transparent and independent credit rating platform.
• Reform Existing Agencies: Pressure should be created to reform the methodology and governance of existing credit rating agencies.
• Fair Chance: Only then will developing countries get a fair chance in the world economy.