The release of the World Bank’s much-anticipated Ease of Doing Business rankings for 2018 couldn’t have come at a better time for the Narendra Modi government. However, the Opposition parties are questioning Prime Minister Narendra Modi for decisions like demonetisation and ‘hurried’ Goods and Services Tax (GST) implementation which they said have pushed the country’s economy to a crisis situation.
The opposition has left no stone unturned to criticise the government’s handling of the economy, and laid specific emphasis on the role that GST and noteban played in the current state. They may be partially correct - India's GDP growth unexpectedly slumped to a three-year low of 5.7 per cent in the June quarter as manufacturers sought to get rid of stocks, rather than making more of them, ahead of the July 1 rollout of the GST.
That, coupled with the lingering impact of demonetisation, resulted in India clocking the the slowest pace of economic growth since the January-March quarter in 2014. The woes do not end there: there is a manufacturing slump and exports stay negative.
While these facts cannot be ruled out, the government has stood by its decisions with a firm resolve and described the pains as transitionary. The government’s ability to carry forward reforms has caught the eye of the rest of the world and the World Bank’s latest rankings attest the Centre’s ability to put the economy back on a robust growth trajectory.
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Silencing critics, however, is not all that makes the Doing Business rankings significant. Rating agencies, who have for long been criticized by the government for not being particularly kind to India, may now find themselves in a bit of a spot.
Despite numerous measures by the government in the last few years, many of which have found mention in the World Bank report, rating agencies such as Fitch, Moody’s and Standard & Poor’s continue to rank India at ‘BBB-‘, the lowest among investment grade ratings and just one notch above the junk grade.
While the World Bank’s ranking will not translate into improvement of conditions in factors that rating agencies look at -- debt-to-GDP ratio, state of public finances and per capita GDP -- they do need to factor in the World Bank’s affirmation to the stark improvement that the country’s business environment has seen since 2014.
There is a bit of history to the assertion that we make here. In May this year, Fitch affirmed India’s ‘BBB-‘ rating citing poor business environment.
"We do recognise that a lot is happening on that front (reforms) but at the same time we have to realise that the business environment in India is relatively difficult. If you for instance look at the ease of doing business indicator of the World Bank which is just one of many indicators, India ranks as one of the lowest if not the lowest of all the BBB category rated countries," Thomas Rookmaaker, Director, Sovereign Ratings, Fitch Ratings, had said then.
Fitch contended that while the reforms were being carried out, they meant little without better business environment. The World Bank’s rankings should thus act as a mirror to the rating agencies. While the government having persistently tried to persuade them of the changes being brought about in many areas, perhaps the latest rankings by the World Bank could help convince them.
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The approach ratings agencies adopt for India hereon will be one to watch out for. These agencies and their ratings are important for any country that seeks investments. A credit rating is an evaluation of the credit risk of a prospective debtor (an individual, a business, company or a government), predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor defaulting.
Significantly, sovereign credit rating indicates the risk level of the investing environment of a country and is used by investors when looking to invest in particular jurisdictions, and also takes into account political risk.
These agencies, however, have often being alleged to have taken a partisan stand against emerging economies. India has been one vocal critic of the stand adopted by these agencies. In fact, the Economic Survey presented on January 31 this year made specific mention of the ‘differential treatment’ of these agencies towards India.
The government is not alone in making this assertion. Several studies and analyses have pointed out how and why these agencies have taken a flawed approach in granting credit scores, with particular mention of countries which enjoy better ratings despite poor performance on many factors that rating agencies look at while according a particular investment status to a country.
"A trend analysis of ratings upgrade and downgrade of countries by S&P indicates that increase in Government borrowings by a country (thereby increasing its fiscal deficit) has not always been associated with a ratings downgrade," wrote the country’s largest lender State Bank of India in its Ecowrap report.
Credit ratings of the developed countries including US and Germany have remained almost stable despite steep increase in their cash (a broader proxy for fiscal) deficits during 2009 (-10.3% of GDP) and 1995 (-7.9% of GDP) respectively. Interestingly, there are instances where fiscal situation has deteriorated but the rating has been indeed upgraded, the Ecowrap pointed out.
Also Read: World Bank Ease of Doing Business Report: India jumps to 100th rank from 130 | Key Points
While the criticism against rating agencies may have gained fervor in the past couple years, revelations alleging a bias is not new by any stretch. Take Harvard University economist Carmen Reinhart’s 2002 study as an example.
Reinhart’s study, that examined data for over 40 economies, covering ratings issued over 1979-99, concluded that emerging economies did tend to receive differential treatment from rating agencies.
Reinhart found that following a currency or banking crisis, rating agencies were much more likely to downgrade an emerging economy, and do so with greater severity.
In the case of Moody’s, the difference between probability of a downgrade in an advanced economy versus that in an emerging economy was as high as 10 percentage points.
Research by Reinhart and other economists has also put rating agencies in a spot over their poor record in predicting currency or banking crises. For example, six months before Greece’s 2010 bailout, Moody’s had issued a note stating that short-term liquidity was not a concern.
Moody’s-rated Developed markets were rated top investment grade three years before they defaulted.
Another paper by Andrea Fuchs and Kai Gehring of the University of Heidelberg showed that ratings agencies tend to rate their home countries as well as countries that share strong economic ties with the home country more favourably.
“While most of the variation in ratings is explained by the fundamentals of rated countries, our results provide empirical support for the existence of a home bias in sovereign ratings.
“We find that the bias becomes more accentuated following the onset of the global financial crisis and appears to be driven by economic and cultural ties, not geopolitics,” it observes.
No wonder then that China, United States’ largest trade partner, continues to receive favourable ratings from US-based agencies.
India not Alone
The bias of rating agencies against emerging economies does not limit to India alone. China, which has otherwise been an outlier as far as the alleged bias towards emerging economies is concerned, too has been critical of the ratings downgrade by Moody’s and S&P.
In an unusual move around 10 days ago, the A1/A+/A+ rated sovereign chose not to seek a rating for its its first US dollar sovereign bond since 2004, Reuters reported.
"The reason is simple: show the world that China does not care about rating agencies' support, or lack of it, and can still get massive oversubscription of its issuance," said Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis, as observers saw China’s snub as a retort to the ratings downgrade.
On September 21, S&P cut China's long-term sovereign credit ratings one notch to A+ from AA- saying its prolonged period of strong credit growth had increased economic and financial risks. The downgrade followed Moody's cutting China's long-term local and foreign currency issuer ratings to A1 from Aa3 on May 24 on concerns that the country's financial strength would erode in the coming years.
There are other nations too who have faced similar bias. Despite lower debt-to-GDP ratio, countries such as Russia, Turkey, Nigeria, and Indonesia are rated worse than India and China, which have much higher government debt.
Prime Minister Narendra Modi and his Russian counterpart Vladimir Putin, during the former’s visit to Russia last year, had vowed to develop a credit rating industry that is “independent from political conjecture”.
In a joint declaration, Prime Minister Narendra Modi and Russian President Vladimir Putin also said they would also explore harmonisation of the respective laws in the two countries regarding credit ratings.
Buoyed by the World Bank’s rankings, India is likely to nudge agencies maintaining a negative outlook towards India to reconsider. India’s stand with respect to their approach towards the country is known well.
Several Indian economists and top bankers have pointed to the hypocrisy of these agencies in according ratings. Critical of rating agencies for giving India the lowest investment grade rating, eminent banker Deepak Parekh wondered how a country with such “strong fundamentals” on both economic and political fronts can be rated so low.
“Why is India, the fastest growing emerging economy for over one year now with all macroeconomic fundamentals being positive, rated just BBB-?“ he had said in June this year.
On the other hand, Italy and Spain, which are far weaker and smaller, are having much higher ratings than us, Parekh said.
“Italian banks are in far worse shape than our banks. Italian government is more shaky and we have a solid political stability now,” he said, while adding that a credit rating is supposed to be based on both economic and political factors.
Agreeing to India’s call for an upgrade is a call that finally rests with these agencies. However, resistance to budge from their stand may further expose them and the duplicity of credit ratings altogether.
For India, the focus should clearly be on strong fundamentals.