Syllabus
GS Paper 3 – Effects of Liberalization on the Economy, Changes in Industrial Policy and their Effects on Industrial Growth.
Context
India recently published a document called ‘Re-examining Narratives: A Collection of Essays’. This document offers different viewpoints on economic policy, which could significantly influence India’s future growth and development objectives.
Credit Rating Agencies (CRA):
- Credit Rating Agencies (CRA): As per the International Monetary Fund (IMF), CRAs are private firms that evaluate the credit risk of borrowers who are seeking loans and issuing fixed-income securities, such as bonds.
- Beneficiary: This term refers to individuals, corporations, state or provincial authorities, or sovereign governments.
- The Role of Credit Ratings: Prospective borrowers often need to secure a credit rating before they attempt to raise funds in capital markets.
- Impact on Lending Parameters: Ratings play a crucial role in determining the interest rate, or price, that the borrower must pay for financing.
- Regulation in India: In India, CRAs are governed by the SEBI (Credit Rating Agencies) Regulations, 1999 of the Securities and Exchange Board of India Act, 1992.
- Registered CRAs in India: There are six Credit Rating Agencies registered under SEBI in India – CRISIL, ICRA, CARE, SMERA, Fitch India, and Brickwork Ratings.
Sovereign credit rating:
- Sovereign Creditworthiness Assessment: This is an independent evaluation of a country or sovereign entity’s ability to repay its debts.
- Determining Factors: Several factors influence this assessment, including per capita income, GDP growth, inflation rate, short-term external debt as a percentage of GDP, economic development, history of defaults, and political stability.
- Transparency: By inviting external credit rating agencies to scrutinize its economy, a country demonstrates its willingness to disclose its financial information to investors.
Significance of Sovereign Ratings:
- Investor Indicator: Sovereign ratings provide investors with insights into the creditworthiness of governments worldwide and their capacity and intent to repay debt.
- Borrowing Capacity Impact: A low sovereign rating can restrict a country’s ability to borrow money from affluent investors. Governments with lower sovereign ratings have to pay higher interest rates when they borrow.
- Business Influence: If a country’s government has a low sovereign rating, businesses in that country face even higher interest rates when borrowing from global investors.
- Development Support: A favorable rating can make it easier for developing countries, which are often capital-deficient, to boost productivity and alleviate widespread poverty.
Important Credit Rating Agencies:
- History of Sovereign Credit Ratings: Sovereign credit ratings have a history that predates the establishment of the Bretton Woods institutions, namely, the World Bank and the International Monetary Fund.
- Major Credit Rating Agencies: The three globally recognized credit rating agencies are Moody’s, Standard & Poor’s (S&P), and Fitch.
- Moody’s: Established in 1900, Moody’s is the oldest credit rating agency. It issued its first sovereign ratings just before World War I.
- Standard & Poor’s: In the 1920s, Poor’s Publishing and Standard Statistics, the predecessors of S&P, began rating government bonds.
- India’s Ratings: S&P and Fitch rate India at BBB, while Moody’s rates the country at Baa3, indicating the lowest possible investment grade. However, the outlook is stable.
- Impact of Global Events on Ratings: While the US and European countries have generally maintained good ratings, these ratings have been influenced by global events. For example, during the 1930s Depression, sovereign defaults increased, leading to a downgrade in most ratings.
Concerns Raised by the Finance Ministry Regarding Rating Agencies’ Methodologies:
- External Influences: The document from ‘Fitch’ reveals that the rating agency is influenced by high levels of foreign ownership in the banking sector.
- Bias Against Public Banks: The methodologies discriminate against developing countries where the banking sector is predominantly public. They overlook the welfare and development functions of public banks, including their role in promoting financial inclusion.
- Lack of Transparency: The selection process for the experts consulted for the rating assessments is not transparent.
- Issues with Weightage Assignment: The agencies do not clearly communicate the assigned weights for each parameter considered.
- Composite Governance Indicator: This indicator, which carries a weight of 21.4, is solely based on the World Bank’s Worldwide Governance Indicators (WGI). These indices include factors such as freedom of expression, media freedom, rule of law, corruption, and quality of regulation. However, they do not capture hard economic data.
Way forward:
- Transparency in Credit Rating: Enhanced transparency in credit rating processes could lead to the use of more hard data, potentially resulting in credit rating upgrades for many sovereign entities.
- Access to Private Capital: Such upgrades could help these entities access private capital, which is crucial for addressing global challenges like climate change and supporting energy transition as identified by the G-20.
Source: Indian Express
Practice Question
Credit Rating Agencies (CRAs) play a significant role in the global financial system. Discuss the function of CRAs and the impact of their ratings on developing countries like India. Also, comment on the concerns raised about the methodologies used by these agencies and suggest measures to enhance transparency and accuracy in the credit rating process. (250 words)