The games they play

ON OCTOBER 10, the global rating agency Standard & Poor's (S&P) lowered India's foreign currency outlook from ``positive'' to ``stable.''

As S&P is lodged snugly in the pantheon of the international financial system, its lowering of Indian rating sent ripples across North Block and Yojana Bhawan.

It is not clear whether there was any causal link between the two; but it is significant that S&P's downgrade came on the same day the Governor of the Reserve Bank of India (RBI) issued the mid-term review of macro-economic and monetary developments. In its review the RBI, among others, downgraded India's GDP growth rate to 6-6.5 per cent from the estimate given a month earlier of 6.5-7 per cent.

It was in a way unkind that S&P's downgrade should have come close to the date of SBI's Indian Millennium Deposit Issue.

In the international market, the lowering of a country rating would have negative influence on debt issues.

India has had an uneasy relationship with rating agencies such as S&P. Since it did not indulge in foreign currency borrowing in the 1970s, they had a negligible role to play.

Those really were the heady days when rating of ``country risk'' was big game that rating agencies and international bankers played while recycling petro-dollars as foreign currency loans. That all the intricate mathematical modelling of ``country risks'' and indiscriminate lending in Latin America lie buried as Brady bonds is another story.

It was again in the beginning of 1990s and with global financial deregulation that the rating agencies came to life again.

India began its encounters with rating agencies after July 1991 when it decided to seek IMF assistance. The ``reform process'' was put through and several measures were taken to open the economy.

A more open role for foreign capital was allowed. Freedom was given to foreign financial institutions to make portfolio investments through the stock exchanges. Indian companies were permitted to raise foreign currency loans or raise capital abroad through ADRs.

Indian involvement in the international financial market brought in its wake a greater role for rating agencies.

Officials of the RBI and the economic ministries in the Government had to spend much of their time providing data and policy clarifications to representatives of these agencies, many of whom were akin to senior inspectors of education departments humiliating headmasters of local schools.

It was pathetic to see the RBI Governor seeking out heads of rating agencies and persuading them to upgrade India's rating.

There is a double bind. If the borrower needs rating by a reputed agency, the lender needs it more. It is known that many investors, including banks, pension funds, portfolio managers and insurance funds rely on credit ratings for making investments.

It is impossible for them to engage researchers and make assessment of risks before making investments abroad. Some U.S. funds are debarred from making investments considered ``speculative'' by rating agencies.

This makes the rating agencies very powerful as they can adversely affect debt programmes by downgrading the borrowing countries/companies.

Country ratings are done as a measure of general guidance to the international market. Company ratings are however done for a fee payable by the borrower.

There are known to be conflicts of interest between the rating agency and the issuing company. While borrowing companies wish to have better ratings to improve their image and the terms of debt issues, rating agencies may not wish to lose their professional `face' by habitual wrong-doing. Often, a compromise may be reached and it is difficult to tell all.

Complexities in country rating

When it comes it country rating, the situation is more complex. There are quantifiable financial data and trends that are now available on IMF portals. But one has to add a lot more variables such as assessment of environment and political stability that are more judgmental than statistical.

There is also the market gossip floating in cocktail circuits, clubs and chambers of commerce. While no agency can reveal its sources, it is admitted that they tend to imbibe gossip and this gossip, by constant reiteration, becomes accepted economic wisdom.

It is worthwhile noting that dependence on rating agencies for financing or lending is not a universal phenomenon. It is an institutionalised American habit. German banks, for instance, rely more on their own internal assessment than on external rating agencies. Mr. Gerhard Hofmann, Head of the Banking Supervision Department, Deutsche Bundesbank, has drawn attention to the fact that there are 8,000 rating agencies in the U.S. as compared to 600 in Europe.

The difference in number, in his view, reflects the differences in banking systems. Banking systems differ from country to country. German and Japanese banks provide large capital to companies without relying on any external rating since they are also interlocked with the boards of companies. Company managers are free from takeover fears and have a longer horizon to plan their projects than American companies which have to worry about stock market returns. There is a move to give the rating agencies a greater role in the revised capital adequacy guidelines proposed by the Bank for International Settlements.

It may be difficult to reconcile the acute differences between the German, Japanese and European approaches to banking and industrial financing with the American. However, while an elaborate exercise is going on in several forums to frame what is called a "new financial architecture", there is an unseemly haste to thrust the American model on developing countries. This gives a special clout to rating agencies. This is unfortunate.

Uneven record

The record of rating companies is uneven. During the Mexican default in 1984 they did not provide proper or adequate guidance. Much later, prior to the eruption of Asian crises in July 1997, not one agency issued warning of any kind about the impending crisis. It may be argued that even international institutions such as the IMF and the World Bank failed to foresee the crises. Instead of trying to play one set of agencies against another, we would argue that all of them were under the same spell of ``irrational exuberance'' over the emerging markets and unwilling to read ground realities. While the IMF and the Bank have their limitations, it is not clear why rating agencies that claim to have objectivity and expertise in analysis of data and forecasting should have fallen into the same trap. We can explain this only by relying on our earlier analysis that market gossip becomes accepted economic wisdom for the members of the club.

Now we come to the recent rating of India by S&P. Except for the impact of high oil prices, there is no reference to any observable or quantifiable data on which the downgrade has been done. It says, ``The outlook revision is based on the Government's inability to accelerate the pace of economic reform.'' It blames the Government for its failure to correct weaknesses in public finances and modernise the public sector.

It draws attention to the failure of the Government to privatise the public sector even after a decade. It ends by saying that ``a better credit standing ...depends on stronger political commitment to address flaws in public finances and reduce fiscal deficits.'' In other words, unless governments (like India) conform to the prescriptions of the IMF reform process, S&P will not upgrade their rating.

Have they become field inspectors for the IMF? Even the IMF, which is in constant dialogue with countries like India, is appreciative of the political and other ground realities and is willing to give a longer horizon for the implementation of the reform process. But S&P is in a hurry and cannot wait. It will downgrade India and make the Indian debt programmes more difficult.

Now we take another rating given by S&P. This is for Indonesia and was done on October 2, 2000. The outlook on the long-term ratings for Indonesia is stable which is the same as for India.

It is contrary to common sense that India and Indonesia should have the same rating. But such are the ways of rating agencies.

The upgrade is based on the fact that two syndicated loans (with a balance of US$850 million) have been rescheduled. It gives credit for the higher oil prices and the improved revenue position. But, on issues like corporate debt, political instability, institutional inadequacies and separatist trends the assessment by S&P is Panglossian. It gives full marks to Indonesia's commitment to reforms and bank restructuring, among others.

But, even its assessments of economic data and trends run contrary to the assessment done by the IMF Executive Board based on Article IV Consultation with Indonesia. And yet, Indonesia has been upgraded and India downgraded. If the credit rating of a country is to be tested by its commitment to ``reforms process'' do we need separate agencies? Can this not be left to the IMF alone?

K. Subramanian

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