Economic Survey Takes a Dig at Rating Agency Methods

The factors used by rating agencies such as S&P do not cover the entire picture, the Economic Survey has said, and it does not look like the same criteria are used for different countries.

Arvind Subramanian. Credit: Reuters/Anindito Mukherjee/Files

Arvind Subramanian. Credit: Reuters/Anindito Mukherjee/Files

New Delhi: In this year’s Economic Survey, chief economic advisor Arvind Subramanian has devoted a special orange box to question the methodology employed by rating agencies. This is particularly visible, the survey claims, not only from crisis periods like the US financial crisis (stemmed by rating agencies certifying as AAA “bundles of mortgage-backed securities that had toxic underlying assets”), but also in more regular, non-crisis situations – like not changing India’s credit rating.

The survey singles out Standard & Poor’s, which ruled out any ratings upgrade for India for a considerable period, mainly on the grounds of its low per capita GDP and relatively high fiscal deficit. But the methodology for arriving at ratings, the survey argues, is clearly more complex – and the factors highlighted by Standard & Poor’s may not be the right ones to evaluate whether India is at risk of credit default.

Why? “Consider first per capita GDP,” the survey says. “It is a very slow moving variable. Lower middle income countries experienced an average growth of 2.45 percent of GDP per capita (constant 2010 dollars) between 1970 and 2015. At this rate, the poorest of the lower middle income countries would take about 57 years to reach upper middle income status. So if this variable is really key to ratings, poorer countries might be provoked into saying, “Please don’t bother this year, come back to assess us after half a century.”

Even on fiscal variables, it is questionable that China’s rating has been upgraded while India’s hasn’t, the survey suggests.

Source: Economic Survey

Source: Economic Survey

“How did Standard and Poor’s react to this ominous scissors pattern, which has universally been acknowledged as posing serious risks to China and indeed the world? In December 2010, it increased China’s rating from A+ to AA- and it has never adjusted it since, even as the credit boom has unfolded and growth has experienced a secular decline. In contrast, India’s ratings have remained stuck at the much lower level of BBB-, despite the country’s dramatic improvement in growth and macro-economic stability since 2014. These contrasting experiences raise a question: can they really be explained by an economically sound methodology?” the survey argues.

There are other factors that these agencies are ignoring, Subramanian argues, that make India capable of carrying more debt than other countries; it has an extremely high “willingness to pay”, for instance.

Ratings agency Moody’s has given India the lowest possible rating, something the Narendra Modi government reportedly lobbied hard against but was unable to change. Correspondence between the agency and the government, revealed by Reuters, showed the rating agency saying they were unconvinced by the government’s rosy picture of its debt situation.

Whatever the government’s reasons may be, methods employed by rating agencies have come under scrutiny from economists across the board, particularly after the 2008 US financial crisis.