What Would It Take To Build An Indian Sovereign Credit Rating Agency For The World

For example, India is given a BBB- or Baaa3 rating, the lowest investment grade, with precious little justification. Ultimately a sovereign rating is an assessment of the creditworthiness, a sovereign’s ability, and willingness to service its debt in a timely manner. This does not do justice to India—a country that has never defaulted on its payments and is today the world's fifth-largest economy, poised to become the third-largest soon. 

While it can be argued that sovereign ratings are opinions and somewhat subjective in nature, the fact remains that they impact the cost of borrowings borne by a nation and its economic agents. It can be nobody’s case that the rating process should be such that mere opinions and subjectivity should determine economic outcomes.

In an earlier article published in The Secretariat, the author made a strong case for India to build an international rating agency of its own. This article thus seeks to define the broad contours and elements of such an agency, which could undo the bias, especially against the developing countries, in the approach of the American agencies that currently dominate the game.

A rating agency from India, which has emerged as a key votary of the global south, would be most appropriate. It would provide a diversity of opinion, also leading to the much-needed debate and discussion over reforming the rating process. 

 But the question is what would it take to build such an alternative that is not only representative of the interests of the developing world but is also seen as credible? Any sovereign rating should be the result of a critical examination of the following parameters:

Economic Structure

The size of the economy and its growth trajectory is a key determinant of a country’s ability to repay its debt.

The primary drivers of this vertical, therefore, would include the nominal Gross Domestic Product (GDP), the GDP per capita (based on purchasing power parity—PPP), real GDP growth and volatility, economic concentration, gross fixed capital formation (as a percentage of GDP) and environmental stability. These indicators will help us assess the economic potential of a country and prospects of sustained growth. 

The secondary drivers, which will need to be factored include the growth potential based on the demographic dividend, consumption and investment potential, economic and political structure, global competitive index, ease of doing business etc.. 

Fiscal Stability

An assessment of a sovereign's fiscal policy, debt profile and prudence in managing public finances will be the next important parameter.

The primary indicators in this case would be the gross general government total debt, the change in gross general government debt to GDP, interest payments as a percentage of revenue and the share of salaries, pensions and subsidies in total government expenditure. 

Incidentally, the US government’s debt to GDP as on December 2023 is 124.3 per cent. Nonetheless, its sovereign rating of the three rating agencies mentioned above is AA+/Aaaa with a stable outlook. 

The secondary factors would include the default history of a country. For instance, Belarus, Lebanon, Ghana, Sri Lanka and Zambia are countries with a history of default as also are Argentina, Ecuador, Suriname and Ukraine. 

Debt maturities, contingent liabilities, quality of expenditure, social expenditure requirements, and tax regime are also all factors that will play out in assessing the fiscal strength of an economy. 

External Linkages

How well a country can absorb shocks emanating elsewhere in the world and how strongly it has cushioned its external transactions with foreign exchange reserves also has a bearing on sovereign rating.

Current account balance, foreign direct investment inflows, the total reserves in months of imports, the external debt stocks as a percentage of gross national income and the total external debt would be the major indicators to be assessed under this head. 

The secondary factors would be the reserve currency status, currency turnover in the foreign exchange market, invoicing in global trade, remittances as a percentage of GDP, and reliance on FII. 

The Central Bank’s monetary policy credibility is in effect under the lens while assessing the factors in this yardstick. This yardstick is an assessment of the sovereign’s external sector to absorb shocks, as well as the ability to build cushions in the form of foreign exchange reserves.

Monetary And Financial Stability

Factors like inflation, exchange rate regime, non-performing loans of banks, private credit, and stock market capitalisation will determine an assessment of this parameter.

The secondary drivers will be the coordination between monetary and fiscal policy, the total domestic savings as a percentage of GDP, the stability of the real estate market, the capital adequacy ratio of banks, the role of quantitative easing, and the Central Bank’s ability to manage a crisis.

Institutions And Quality Of Governance

While all the parameters mentioned above are data-driven and measurable, the final parameter assessing institutional resilience and governance quality will involve a significant share of subjectivity. It is a critical parameter because if the institutions are weak and governance standards are not robust, all the other yardsticks like economic structure and fiscal stability also tend to suffer.

The primary drivers of this parameter would include an institutional framework to control and curb corruption, which can otherwise eat into the vitals of the economy, accountability and the rule of law, regulatory quality and government effectiveness and most importantly political stability and the absence of violence.  

All these are essential for a country to do economically well and to get the confidence of investors and foreign investments. Transparency of processes is essential as well as the reliability of statistical information, data, and the strength of the institutions to handle any black swan event.

Thus, what should be looked at here is the existence of a stable and predictable governance and policy environment. The World Bank Worldwide Governance Indicators make a good example in this regard.

Summing Up

Primary indicators would be quantitative, using past and predicted data; secondary factors will be country-specific, where a more nuanced, analytical approach will be needed. Each of the parameters would be assigned a weight, not necessarily a uniform one. Economic Structure and Fiscal Strength will carry a relatively higher weightage as these pillars make the macroeconomic foundation of any country.

The proposed framework is not dissimilar to what has been in use by agencies such as S&P, Moody’s or Fitch. The difference primarily lies in the weightages assigned to different parameters and minimising the subjective part of the assessments. 

Obviously, a global rating scale that is uniform across countries should be adopted. It could range from a high of AAA, denoting the highest degree of ability to service debt, to C, denoting imminent likelihood of default, and culminating in D, which would denote default. Default would be defined as the failure of a sovereign to honour any promised debt servicing obligations.

India is on the cusp of taking off to the next stage of economic development. It would be appropriate for a credit rating agency without the burden of foreign parentage to step in and fill a much-needed void—an international credit rating agency from India that is credible, fair, and unbiased.

It will be a long journey fraught with many challenges, including from the established players, but it will be a journey worth the effort. The time has come to take the first steps. 

(The author is a former chairman of the Central Board of Indirect Taxes and Customs. Views expressed are personal.)