To address the challenges posed by existing credit rating agencies and their biases against the Global South, particularly India, several operational changes need to be implemented.
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For years, the Sovereign Credit Ratings (SCR) assigned by the top three financial agencies—Moody's, S&P, and Fitch—have had a tangible impact on access to global capital and varied investor perceptions of individual countries. However, concerns have been raised about the subjectivity and bias influencing the accuracy of these ratings. This article attempts to discuss the bias present in the sovereign credit rating methodologies, with a particular focus on India’s case.
India has shown a positive growth trajectory in the past decade, overcoming the recent COVID-19 pandemic and other geopolitical conflicts, making it the fifth-largest economy in the world. Despite these positive attributes, India's sovereign credit ratings by the three major credit rating agencies (CRAs)—Fitch, S&P, and Moody's—remain low (BBB-/Baa3). The economic survey of 2021 criticised credit rating agencies, accusing them of bias against emerging giants like India. Similarly, a report by the Office of Chief Economic Advisor, Ministry of Finance, Government of India (2023) came out with a review of the sovereign credit rating methodologies, concluding that these methodologies are highly subjective and depend on a few experts' opinions. These ratings essentially fail to assess India's economic growth objectively. Due to the opaqueness of their methodologies, it is difficult to fathom whether they are unfairly biased against the Global South or specifically towards India. Moreover, most of India’s public debt is in domestic currency, which makes the possibility of default close to zero. In fact, India does not have a default history.
India has shown a positive growth trajectory in the past decade, overcoming the recent COVID-19 pandemic and other geopolitical conflicts, making it the fifth-largest economy in the world.
Some argue that India is dealing with high inflation and a high debt burden, which is why the credit rating is low. However, the responsible authorities have taken steps to control inflation, which is 4.83 percent (based on all India CPI) as of April 2024 and keep a check on the debt burden. India has substantial foreign exchange reserves—as of March 2024, India's foreign exchange reserves stand at approximately US$570.95 billion, showing a significant increase over the years. Additionally, India's banking system remains well-capitalised and continues to show liquidity and asset quality resilience. Moreover, India continues to attract increasing foreign direct investment, with recent trends indicating robust growth and confidence from international investors. There is vast academic literature discussing these CRAs' bias against emerging economies and the Global South. This gives rise to perception premiums and makes it difficult for emerging economies like India to access international capital markets. The credit rating for India does not reflect its economic fundamentals at all. This was highlighted in the Economic Survey 2021, published by the Ministry of Finance, Government of India.
The determination of credit ratings for sovereigns commonly employs a letter grading system. These ratings play a vital role in the interlinked global economy, significantly influencing countries' economic and political landscape, even though they constitute a small part of the credit rating industry, considerably impacting a country's ability to access international capital markets and borrowing costs. Additionally, they are widely regarded as a crucial tool for investors to assess a country's ability to fulfil its financial obligations and determine its creditworthiness at any given time. SCRs evaluate sovereign entities’ “ability to pay” and “willingness to pay” to fulfil their debt obligations. It's interesting to note that the significance of these ratings has grown in recent decades in tandem with the expansion of global financial markets. As mentioned above, the methodologies employed by major credit rating agencies, such as S&P, Moody's, and Fitch, have been subjected to criticism due to concerns about their transparency.
The determination of credit ratings for sovereigns commonly employs a letter grading system. These ratings play a vital role in the interlinked global economy.
One of the main criticisms of current rating methodologies is their heavy reliance on qualitative indicators, which introduces several challenges. Firstly, these methodologies often depend on the opinions of a small group of experts, which can lead to subjective judgment and reduce the overall reliability of the ratings. Secondly, the over-emphasis on qualitative indicators exacerbates the issue of subjectivity, leading to potential cognitive biases and bandwagon effects. Lastly, there is a significant lack of transparency regarding the specific methodologies employed, particularly in evaluating qualitative factors such as institutional quality. For instance, there are issues about the transparency of specific qualitative factors, such as institutional quality, as measured by the World Bank's Worldwide Governance Indicators (WGIs). These evaluations can be subjective, as they depend on the opinions of a few experts. These factors collectively undermine the trustworthiness and credibility of the ratings.
Domestic credit rating agencies should be encouraged to develop sovereign credit ratings, especially for India. Countries like Japan and China have the Japan Credit Rating Agency (JCR) and China Chengxin Credit Rating Group, respectively, rating their sovereign debts. India has some well-known credit rating agencies, such as the CareEdge group, CRISIl, and ICRA, to name a few. Rating a sovereign cannot follow a standardised “one-size-fits-all” methodology and needs an in-depth analysis of a country's economy. Local credit rating agencies can understand the nuances of the Indian economy better and can offer a more tailored assessment of the same. The top three CRAs, based in the Global North, the United States (US) to be specific, form an oligopoly in the credit rating market. Upliftment of Indian credit rating agencies is thus needed to increase representation of the Global South. This will further encourage other developing countries to showcase their economic capabilities. It is interesting to bring forward a recent development wherein S&P has upgraded India’s sovereign rating to ‘positive’ from ‘stable’ while retaining the rating at BBB-.
Domestic credit rating agencies should be encouraged to develop sovereign credit ratings, especially for India. Countries like Japan and China have the Japan Credit Rating Agency (JCR) and China Chengxin Credit Rating Group, respectively, rating their sovereign debts.
To address the challenges posed by existing credit rating agencies (CRAs) and their biases against the Global South, particularly India, several operational changes need to be implemented. Firstly, the Indian government should actively support and empower domestic credit rating agencies and think tanks to provide sovereign debt ratings, reducing reliance on international CRAs and promoting more localised and potentially accurate assessments. Secondly, it is crucial to develop and advocate for a more objective and transparent methodology in determining sovereign credit ratings. Ensuring transparency in rating methodologies is essential to eliminate the perception premiums that often disadvantage developing and underdeveloped countries. Clear and open criteria will build trust and reliability in the ratings issued. Additionally, introducing a separate rating scale for emerging economies, which lies between national and global scales, is necessary. This scale should account for the unique complexities and conditions of emerging markets, thereby providing a more accurate assessment of default risk based on relevant parameters. An emerging market credit rating scale will better distinguish the credit quality of issuers in these regions, enabling investors to allocate funds more efficiently and confidently to trustworthy companies. Finally, the practice of limiting corporate ratings based on sovereign ratings needs to be reformed to prevent the unfair penalisation of highly reliable companies whose profitability and creditworthiness are adversely affected by their country's sovereign rating. By implementing these changes, we can foster a more equitable and accurate credit rating environment, mitigating the biases that currently hinder the Global South's economic potential.
Manya Khanna is a Research Intern at the Observer Research Foundation.
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