Ratings game

International credit rating agencies have pushed for financial liberalisation in emerging markets, threatening downgrades if certain policies are not adopted.

The recent downgrade of India as a sovereign borrower by the United States-based Fitch has come close on the heels of similar downgrades and placing on negative watch by the international credit rating agency Standard and Poors. In April, S&P lowered Indias rating outlook from stable to negative, and in June it warned that India would become the first fallen angel among the BRICS (Brazil, Russia, India, China and South Africa) nations to get a sovereign credit rating below investment grade.

These moves have created hysteria in much of the media and near panic in official circles. The domestic financial press, being more susceptible to external perceptions than internal forces, is treating this as spelling doom for the Great Indian Growth Story. Some official spokespersons have tied themselves in knots by apparently agreeing with the substance of the analysis of these agencies, but disagreeing with the conclusions.

Others, including Finance Minister Pranab Mukherjee himself, have tried to put a brave face on the matter, saying that these agencies have based their actions on older data, which are no longer the correct indicators. Even so, Pranab Mukherjee declared that the government had taken note of the concerns raised by Fitch and others and would take further appropriate measures in addition to those that had already been taken (which include dubious policies such as the fertilizer subsidy reform and the capping of subsidies as a percentage of gross domestic product.

In fact, the likely domestic policy reactions to these downgrades are of much greater concern than the actual analyses and predictions of these agencies, which are problematic at best. The international credit rating agencies have not exactly covered themselves with glory in the past few years, and in many countries there have been calls to regulate them and look for some ways to ensure greater accountability for the enormous power they have to influence markets.

Throughout the global boom, and particularly in the U.S. and some European countries, these rating agencies were consistently behind the curve, failing to point out the obvious problems and weaknesses in many of the institutions (public and private) to which they gave Triple A investment status. The conflicts of interest involved in such behaviour are clear, but there has been no serious attempt at controlling them.

Nor is there any accountability or responsibility for their actions. When it became clear in the U.S., for example, that much of their analysis and rating was plain wrong and downright misleading and had led retail investors and pension funds into putting their investments into completely risky and sometimes even fraudulent financial assets, these agencies blandly declared that they could not be held responsible since they were only offering opinions. The fact that these opinions have a huge influence on markets, also because in many countries certain types of investors, such as pension funds, are forbidden from taking on any assets below investment grade, is apparently not their problem: they are just in the business of offering advice based on their own opinions.

There is more than irresponsibility at stake here. It has also become clear that these agencies behave in ways that not only affect their own business interests but are sometimes blatantly political, pushing for policies that benefit finance and sometimes even in a politically partisan manner. It is no secret that the downgrade of U.S. sovereign debt (which incidentally had the opposite effect of making it even more attractive in the financial markets!) just before the U.S. Congress had a vote on allowing the fiscal deficit level to rise was designed to play into the hands of Republican opponents of the government.

In emerging markets, these credit rating agencies have played even more dangerous games, pushing for more financial liberalisation that is directly in their own interest, threatening downgrades if certain policies are not undertaken all in the name of objective analysis to provide their opinions. Yet, a systematic study of these opinions would probably reveal how wrong they have been in so many instances, or how late they tend to be in coming up with changes in their ratings, very much following the curve of market cycles rather than providing any useful projections for the future.

This is also the case for their analysis of the Indian economy, which appears to be either a bit slow to realise some basic facts, or heavily influenced by the desire to push for policies in the interest of global finance rather than the Indian economy. For example, Standard and Poors based its recent assessment on the fact that the division of roles between a politically powerful Sonia Gandhi and an appointed Prime Minister had weakened the framework for making economic policy. But this supposedly destructive division has been in place since 2004, throughout the period of boom, which the same agency celebrated with its many earlier positive assessments.

Similarly, Fitch has cited corruption as a concern and a reason for the downgrade. But, surely, this is not something that has suddenly happened this year in India. Was there no such corruption two years ago, when Fitch was so bullish about Indias prospects, especially compared with the rest of the world economy? If anything, more of the earlier scams in India are now being exposed, which makes current ones at least slightly less likely.

Fitch has also cited lack of reforms and gone on to argue that Indias medium- to long-term growth potential will gradually deteriorate if further structural reforms are not hastened. This is an open push for reforms to benefit large corporate capital in finance and elsewhere, which is not at all the same thing as policy changes that will put the Indian economy on a sustainable and employment-generating growth path.

Indeed, that may be the crux of the problem. It is certainly true that the recent Indian success has been based in large part on the favourable perceptions of global capital, which generated capital inflows. But these inflows have not really been of the kind that generates more productive capacity and work along with access to new technologies and markets. Rather, financial inflows have dominated and have contributed to a boom driven by consumer credit (including for real estate) and debt-driven high spending by corporations, generating growing current deficits in the process.

This is not a sustainable trajectory, nor has it provided better employment and living conditions for the bulk of the population. To ensure a more stable and inclusive growth, the Indian economy needs to get on to a different path by generating more productive employment that provides basic needs to all the population. This is not likely or even possible given the incentives created by the past pattern of capital inflows. If anything, incentives actually militate against such a desirable change in strategy.

Thus, one of the adverse fallouts of this process has been the obsession with the GDP growth rate, regardless of the content of that growth. GDP can grow even when the real economy stagnates, if there is a boom in asset markets that generates real estate and construction activity and inflates financial sector GDP. But, unfortunately, this obsession with growth has not just been within finance but has also permeated industrialists, who should rather be concerned with their absolute profits and the size of their markets. And it has contaminated policymakers as well, as they focus single-mindedly on the quarterly GDP growth figures without looking at the composition of that growth and whether it is translating into higher employment and better material conditions for the bulk of the population.

In this context, it is evident that if the credit rating agencies had actually continued to be bullish on India, we would be getting further into the creation of an unsustainable bubble, the inevitable bursting of which would be even more painful. What is the point of getting lots of speculative inflows of hot money that do not translate into productive investment that creates employment? Why encourage the continuation of macroeconomic imbalances that are fundamentally undesirable? So why should we bother about the opinions of these external credit rating agencies? Maybe we would all have been better off without the destabilising influence they have played and continue to play in India and in the rest of the world.