Rating constraints

India's economic size and complexity offer advantages

Economists at the Union Ministry of Finance, led by Chief Economic Advisor V Anantha Nageswaran, came up with a collection of essays last week. Dr Nageswaran and his team must be commended for bringing out this volume, which offers insights and contributes to the ongoing policy debate in areas such as inequality, India’s international trade position, and financing climate action. The volume begins with the issue of sovereign credit ratings and its associated problems. The Union government’s disagreement with the rating process is well known and it has raised the issue with global rating agencies in the past. The matter was also dealt with in detail in the 2020-21 edition of the Economic Survey.
 

Credit ratings are an important part of the modern financial system and are expected to guide lenders about the borrowers. Lower ratings affect both the availability and cost of credit. While the mechanism is relatively straightforward for firms in the private sector, things get fairly complicated in the case of governments, partly because of the parameters considered for awarding the ratings. In this context, finance ministry economists have rightly pointed out that methodologies used by rating agencies are opaque and tend to disadvantage developing economies. The essay highlights several issues with the present system of ratings, which leaves a lot to be desired in terms of transparency. The process has become more important because of the general increase in public debt owing to the pandemic, which has made developing countries vulnerable to rating downgrades. For instance, as the essay notes, between 2020 and 2022, over 56 per cent of African countries were downgraded by at least one of the big three rating agencies. But in the case of Europe, it was only 9 per cent.
 

In India’s case specifically, as the Economic Survey 2020-21 also argued, sovereign credit ratings do not depict the real underlying position. India, for instance, has been one of the fastest-growing large economies for several years, it holds one of the highest foreign exchange reserves in the world, the government’s exposure to foreign debt is minimal, and it has never defaulted. However, it is still assigned the lowest rating in the investment grade, which is seen as unfair. While there are certainly issues with the methods adopted by rating agencies, it has also been proved on several occasions that they tend to be way behind the curve and demonstrate herd behaviour, particularly in times of stress.
 

Since sovereign rating is an external constraint that India will perhaps have to live with, what is worth debating is whether it is affecting macroeconomic management or growth potential. Would an upgrade, which India arguably deserves, improve its longer-term growth potential and reduce macro risks? Unlike many developing economies, the size and complexity of its economy offer India enormous advantages at the global level, enabling it to attract substantial savings. Indian government bonds, for instance, are now being included in a widely tracked global bond index. More such inclusions may follow. Broadly, India has been able to finance its current account deficit fairly comfortably in recent decades. To attain higher sustainable growth, to be fair, it will need more savings. However, a large part of it will need to be found domestically, which could be made possible by containing the general government Budget deficit at a lower level. Large government borrowing is a risk for both future growth and sovereign ratings.