Moody Blues — the fickle world of ratings

Atanu Biswas | Updated on May 27, 2021

Ratings Boon or bane?   -  fazon1

Rating agencies have got things horribly wrong in the past. But they still carry a lot of heft in the global economy

Although hundreds of rating companies deal with economic and financial matters, three major companies, known as ‘Big Three’, hold 95 per cent collective global market share — Standard & Poor’s (S&P) and Moody’s having approximately 40 per cent each, and Fitch Group around 15 per cent.

Thanks to Covid’s deadly second wave, Moody’s has now cut India’s GDP forecast for FY22 to 9.3 per cent from the earlier projection of 13.7 per cent, and has ruled out a sovereign rating upgrade — at least for now. Incidentally, in June 2020, citing structural weaknesses, weak policy effectiveness, and slow reforms momentum even before the pandemic, Moody’s cut long-term sovereign rating for India from ‘Baa2’ to ‘Baa3’, which is just one notch above ‘junk’ status.

In 2017, Moody’s upgraded India’s long-term sovereign rating to Baa2 from Baa3. How important are such ratings? How correctly do they portray the economy? And what’s the consequence? Are they reflection of the past, or an indication of the future? Did the 2017 upgradation really help India’s economy?

In today’s world, ratings reflects the credibility of an organisation. Actually, the rating culture has been dominating every bit of our lifestyle. The rankings of universities also create huge uproar. Many people believe that the ratings played a major role to build a bubble out of the housing industry in the US, which subsequently was responsible for the financial crisis during 2007-09.

Uneasy legacy

Such credit rating companies have consistently rated many real estate business organisations tripple-A, the highest rating, over years, until the market crashed. Many in the US still struggle to understand the rationale and the underlying mechanism of such ratings.

According to Moody’s own reports, AAA investments “should survive the equivalent of the U.S. Great Depression.” Then, how could the same rating agency mark many of these organisations in ‘junk’ categories in 2010?

The 2015 movie ‘The Big Short’, (which provided a crash course both on the 2007-08 global financial crisis and the functioning of rating agencies) however, accused the short-sighted greed of the credit rating agencies for such a disaster. In one scene of the movie, a lady staff of a major credit rating agency says that if her company doesn’t grant a AAA rating, one of their customers, the Wall Street bank, would simply approach a competitor to get a high rating from them.

Certainly, the reality may not be as bad as depicted in this movie, for any company could then easily ‘buy’ an AAA rating. However, American journalist Matt Taibbi, wrote: “the financial crisis happened because AAA ratings stopped being something that had to be earned and turned into something that could be paid for.”

There is not much control or regulation on the ratings of these agencies. Their business rolls on even if they make huge mistakes having tremendous economic implications. Interestingly, they rate an organisation mostly on the basis of the data given by their clients. Also, importantly, the too simplistic economic models they use maybe inadequate to assess the complicated reality. What’s more, they take high fees from their clients, and rate them. Is there an apparent conflict of interest in this system?

However, do we, in India, have enough strength to disregard such credit rating agency’s worldwide acceptability? It seems that the world does care for such ratings.

In 2012, France lost its triple-A credit rating with S&P, which was a clear blow to President Nicolas Sarkozy three months from a presidential election. Again, Greece, Portugal, and Ireland had their sovereign debt downgraded to junk status by international credit rating agencies during the European Sovereign Debt Crisis, which essentially worsened investor fears.

In 2011, S&P downgraded debt rating of the US to AA+, one notch below the top grade, for the first time, and the Obama administration reacted with indignation, noting that the company had made a significant mathematical mistake.

Thus, nobody can ignore the ratings importance, although, during the last few decades, many major rating agencies failed miserably to predict incidences like the Asian economic crisis, Enron, subprime mortgage crisis, Lehman Brothers, Greece.

Earlier, the European Union considered setting up a state-supported EU-based agency. Also, there have been discussions of introducing coherent rating system by organisations like the UN. Until something like that takes place and is accepted worldwide, nobody can deny the utility of the Big Three.

Moody’s mood does matter for the time being, of course.

Apparently the credit rating agencies should have much stronger influence in the service sector economies, where high ratings are essential to attract customers. Some short-term effects can be seen in the economy, for sure, in terms of dollar-rupee exchange rate, share market, interest rates, or redistribution of wealth or business. However, it is not clear whether Moody’s or S&P can influence the base of the huge Indian economy, just by increasing or decreasing the rating by a notch or two.

The writer is Professor of Statistics, Indian Statistical Institute, Kolkata

Published on May 26, 2021

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