Sovereign ratings is for state; at the margins for markets

That the key Indian stock index closed 0.9 percent lower, and the benchmark bond yields rose two basis points, on a day when Standard & Poor’s raised India’s sovereign outlook to positive from stable reflects a stark reality. That the rating view just doesn’t matter to the markets anymore.

Sovereign ratings, a product of the pre-depression era when analysts were a rarity and communication was expensive, are turning into dinner-table conversations rather than driving investment decisions.

What drove S&P’s decision to upgrade the outlook barely a week before the election results were to be declared, with little idea of how the government finances were going to look like under a new regime?

"The positive outlook reflects our view that continued policy stability, deepening economic reforms, and high infrastructure investment will sustain long-term growth prospects," said a statement from S&P. "That, along with cautious fiscal and monetary policy that diminishes the government's elevated debt and interest burden while bolstering economic resilience, could lead to a higher rating over the next 24 months."

To be sure, it is not a sovereign rating upgrade as yet. That probably has to wait for two more years.

"We may raise the ratings if India's fiscal deficits narrow meaningfully such that the net change in general government debt falls below 7% of GDP on a structural basis," it said. S&P's projections show it falling to 6.8 percent by fiscal 2028.

There are still investment institutions that follow the global rating companies due to historical reasons, but much of the investment community is served by thousands of analysts and macro-economic experts that are well ahead of rating companies.

S&P’s rationale that the economy is on a roll when compared to peers, government finances are getting stronger, and infrastructure spending augurs well for the future, is actually lagging behind what market analysts have already factored in.

After nearly a decade of hesitation, JPMorgan included India in its key emerging markets bond index. Foreign portfolio investors have been pouring in money for years taking the foreign exchange reserves is close to $650 billion, a record. Equity indices are near record high and global corporations from Apple to Google are lining up to invest in India.

The institutional structure and the constraints on the way rating companies approach sovereign ratings may slow them, but it is also their reputation that lay in tatters post the Global Financial Crisis of 2008.

These institutions failed to capture the meltdown that was happening in the US subprime housing market. In 1997, they were caught napping when the Asian Crisis unfolded.

So, who bothers about the sovereign ratings by the global Three, S&P, Moody’s and Fitch? The state!

The 2021 Economic Survey devoted a full chapter charging the rating companies with bias and ignoring the economic fundamentals.

"As ratings do not capture India’s fundamentals, it comes as no surprise that past episodes of sovereign credit rating changes for India have not had a major adverse impact on select indicators such as Sensex return, foreign exchange rate and yield on government securities," said the Survey. "Past episodes of rating changes have no or weak correlation with macroeconomic indicators."

While investors may ignore the actions of rating companies, the state's charges of bias highlight its keenness to get an upgrade, if not for anything else, at least to showcase its arrival among the top five economies.