View: Moody's downgrading of India's credit ratings has its own bias

By Shashwat AlokThe rupee and stock markets didn’t react and, if anything, posted modest gains on Tuesday, the day India’s credit ratings were downgraded to Baa3 by Moody’s. It is possible that markets had already expected and priced in a downgrade. Alternatively, the Street may have subsumed that these sovereign ratings tend to be biased and, consequently, discount the information content — or lack thereof. The truth, as usual, lies somewhere in between.It was just another day in 2019 when Moody’s had changed its outlook of India from stable to negative. Over coffee, my colleague and I noted that some countries tend to have worse ratings as compared to other economies with similar economic fundamentals. For instance, India had never defaulted on its debt. Yet, it received lower/similar ratings than countries with comparable/worse economic fundamentals. India did come close in 1991, but didn’t default.Instead, Prime Minister P V Narasimha Rao had ferried 47 tonnes of gold to the Bank of England as collateral. In contrast, the US has defaulted twice. Portugal, which has defaulted four times, also has a credit rating of Baa3. Could cultural or socio-political biases explain the difference in ratings across seemingly comparable nations? Using linguistic similarity as a proxy for cultural proximity, Andreas Fuchs and Kai Gehrig in their 2017 paper, ‘The Home Bias in Sovereign Ratings’, examined the determinants of sovereign credit ratings for 143 countries by nine rating agencies. They concluded that nations culturally similar to the ‘home’ countries of the rating agencies tend to receive a higher rating than comparable countries with the same economic and political fundamentals.Further, geopolitical ties notwithstanding, countries whose downgrades could pose a risk to the home country banks receive higher ratings. One could argue that the higher ratings lend themselves to rating agencies’ access to ‘better’ information regarding culturally aligned countries. The researchers rule out this thesis. They find that optimistic expectations and bilateral trust, rather than an information advantage regarding culturally proximate nations, drive the difference in ratings.So, rather than being engines of informational efficiency, sovereign ratings may reflect heuristic biases. Fuchs and Gehrig recommended greater transparency in rating decisions, and the use of cross-cultural teams to mitigate such biases. To the extent that some of the bias may also be driven by geopolitical pressure, one would recommend that India have its own independent and unbiased rating agency.We certainly have the expertise to do it. For instance, Centre for Advanced Financial Research and Learning (Cafral), the Reserve Bank of India’s (RBI) policy research wing, has enough intellectual horsepower to come up with its own ratings. If such a rating were to be freely available, and have a transparent model, it could serve to increase the competitive pressure on external rating agencies, forcing them to be less biased. Until that happens, the economic doctors advise that rating downgrades, such as Moody’s latest, be consumed with a pinch of salt.(The writer is research director, Digital Identity Research Initiative (DIRI), Indian School of Business, Hyderabad)

from Economic Times https://ift.tt/2MqhVhS