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India Is Unfairly Rated

Context

  • With a high degree of investor trust, India is one of the countries that receives the most foreign direct investment (FDI) and foreign portfolio investment (FPI). However, international credit rating agencies appear to have a preconceived notion about how to assess India’s economic structure.
  • Fitch’s sovereign rating has been kept at BBB-, which is just above investment grade and denotes an outlier.

Relevance:

GS Paper-3: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development, and Employment

Mains Question

For their inaccurate assessment of India’s sovereign rating, credit rating firms have come under fire. Describe the elements that support a higher rating for India and the necessity for credit rating companies to modify their procedures in light of the current situation.


Companies vs. Sovereigns in Credit Rating

  • The idea of a sovereign’s credit rating is distinct from a company’s.
  • Credit rating agencies must take this risk into account when assessing a sovereign’s creditworthiness because countries can always print money to repay their debt, even at the risk of high inflation.
  • While the agency evaluates the probability of default for companies based on their performance parameters, it evaluates the overall economic structure of the country for sovereigns to determine whether it can default.

Is this assessment appropriate for India?

  • For India, however, practically all debt is completely in rupees, and even FPI involvement is in rupee bonds, therefore there is never a case of FX risk for India. Such an appraisal can be justified if countries have external exposure.
  • The perception of the economy by investors is the deciding factor in a country’s credibility, thus if international investors are optimistic about India, a rating of only investment grade seems out of the ordinary.
  • Since there is complete capital account convertibility there, these investors are genuinely putting their money on the table and have never experienced any problems pulling it out.

Strong Arguments for a Rating Upgrade:

  • excellent Growth Statistics: o Even without comparing it to other countries, the growth rates of 7% in FY23 and 6-6.5% predicted for FY24 are pretty excellent.
    • The performance is more than commendable, even though it falls short of the potential of 8–8.5 percent after the Covid blow.
  • Nuanced Approach to Fiscal Stimulus: o In comparison to other countries, India took a particularly nuanced approach to fiscal stimulus during the crisis.
    • While expenditure was adjusted by reform and policy actions, revenue was delayed.
    • The industry benefited from using banking channels to provide support, while the financial system benefited from guarantee programmes.
    • There is a commitment to returning to the road of fiscal restraint in a short amount of time.
    • Expenditure is being reduced, as seen by the merger of the free food programme and the food subsidy.
  • Banking System Rebound: The Indian banking sector has made a strong comeback and has taken advantage of the epidemic era to straighten out its records.
    • This improves the banking system’s ability to offer financing and makes it possible for the economy to go to a higher development path.

The function of the RBI is as follows:

  • Smooth Withdrawal of Accommodation: o In comparison to other countries’ central banks, the RBI has ensured a smoother route to normalcy.
    • In this case, the accommodation withdrawal went well and was done inconspicuously.
    • The interest rates have also changed in this area without having a significant impact on growth. This is significant because bond yields have moved within a smaller range in India, preventing the same level of volatility that has been experienced in the US as a result of the Fed hiking interest rates.
  • Strong forex situation: o The RBI has made sure of two things: o First, as the dollar appreciated, the rupee always maintained the median level of depreciation compared to other currencies, ensuring there was no market panic and maintaining the competitive edge for exporters. o Second, forex reserves, which declined primarily due to valuation issues, have regained their level with a comfortable import cover ratio of just above nine months. The balance of payments is greatly aided by this.
  • Better quality of public spending: o The Budget boosted the share of capital expenditures from 12–13% before the epidemic to 22% for FY24.
    • Despite the year’s several approaching assembly elections, the Budget has chosen to practise fiscal restraint.
  • innovative trade agreements: o India’s ability to pioneer innovative thinking on the trade front, as evidenced in the rupee trade agreement with Russia, which has since won popularity with numerous countries, was a significant development during the year.
    • This is a significant step since these agreements can assist nations in reducing their reliance on the dollar and the euro, which will strengthen their economies.
    • Although going domestic is a novel approach, it is a slow process that will take time to perfect.
    • The rating agencies need to recognise this since it is a model that many emerging nations will find valuable.
  • Digitization: India has made incredible progress in this area, from banking to the Covid vaccine campaign.
    • The digitization drive has changed the economy’s structural makeup, making systems more effective.

Conclusion

  • In order to maintain their reputation, international credit rating agencies must reinvent themselves and go back to the basics.
  • India merits a fair and unbiased assessment given its distinctive domestic business strategy.
  • The commentary supplied about India is typically positive, and the low rating given is unjustifiable.
  • The rating procedures need to change to reflect the changing times since outdated mindsets undermine the credibility of the rating agencies.
  • The rating agencies need to recognise India’s strong economic success and give it the rating it merits

February 2024
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