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Decreasing Sovereign Credit Rating of India and its Implications

Written by Aman Guru [i] and Aman Tenguria [ii]

[i] Fifth Year and [ii] Fourth Year student of Symbiosis Law School, Pune


Source: Money Crashers


Disclaimer: Please note that the views expressed below represent the opinions of the article's author. The following does not necessarily represent the views of Law & Order.


Sovereign Credit Rating (hereinafter ‘SCR’) can be understood as a rating delineated by credit rating agencies to set out a holistic view of the creditworthiness of a country ensuing an independent assessment to highlight the risks associated with investing in a particular country including the political risk. Credit Rating Agencies (hereinafter “CRA”) analyse the creditworthiness of a country to issue debt bonds/securities. SCR is an independent assessment evaluated by CRA. While evaluating SCR, CRA considers parameters like fiscal and monetary flexibility, political situation, debt burden etc.[1] Fitch, S&P, Moody’s are the most influential international credit rating agencies.[2]


Types of Sovereign Credit Rating:

  1. Investment-Grade Rating – It denotes that government or company bonds have low levels of risk. Grade of AAA, AA, A, BBB (Agency Fitch) or above falls within Investment Grade and denotes that risk would be low in such countries. Additionally, Investors through Foreign Direct Investment invest in the countries having an investment-grade rating.

  2. Junk-Grade Rating – Whereas junk-grade denotes such countries would have a high level of risk. Mostly, individuals and Institutional investors have a rigid policy of limiting investment in Junk-graded countries. Grades below BBB like BB, B, CCC fall within this category.

Recently, Credit rating agency Moody’s has downgraded India’s sovereign rating. Reasons stated for downgrading is the increase in fiscal deficit and revenue deficit. Furthermore, this has led to higher debt burden during the lockdown.[3]

Impact of downgraded rating on India’s trade & International Investment :


Presently, India’s SCR is BBB, the lowest in the investment-grade. Such a credit rating could have a negative effect on India’s trading prospects. Furthermore, the degraded economy during the lockdown if falls further in grade could land India in the category of junk graded countries. Insurance firms, sovereign debt funds, sovereign wealth funds will restrain from investing in India if this were to happen. A low sovereign credit rating shows a high level of risk in repayment of loans. Consequences of high risk in repayment is an increase in the rate of interest charged by domestic banks. The Secured loan by keeping bonds as collateral will comparatively have low security whereas unsecured loan prima facie have high risk. In turn, it also affects MSME sectors and other borrowers by levying high interest on the loan from the bank or other financial institutions.[4]


Foreign direct investment (hereinafter “FDI”) is the direct cross-border investment through which investors from donor countries invest in a recipient country.[5] FDI plays a vital role in development especially when it is a developing country since it also helps in promoting the domestic product in the international market.[6] Further research suggests that a sovereign nation with a positive credit rating (recipient country) attracts a considerable amount of FDI in comparison to the scenario otherwise. The investors look for investment-grade countries because they have relatively low risk on investment. The decrease in FDI can also be associated with the withdrawal of capital from the Indian market by investors. Considering MSME and other sectors since they are the backbone of Indian Economy. Ramifications of having less FDI would be borne by MSME and other sectors either by paying a high rate of interest to banks or by shutting down the business. During this Global Crisis, Indian companies or MSME cannot afford their foreign investors back off or an increase in the rate of interests of banks, and etc. due to a downgraded SCR. Therefore, Less FDI would certainly decrease the trading graph in India.


Decreasing sovereign credit score – Implication on Economy :

A stimulus package of Rs. 20 Lakh Crore i.e. 10 percent of India's GDP was announced by the Prime Minister to provide relief to migrant workers, credit to MSME sectors, and other reliefs.[7] Out of which, around 3 Lakh Crore to MSME was more inclined towards production with no direct relief and the government failed to consider the aspect of demand for goods.[8] Manufacturers are reluctant to borrow capital from banks on a certain rate of interest to produce more and more goods because there is no demand. If the production continues and demand graph does not rise, the stimulus package of providing credit to MSME would give no relief to them. An increase in the Financial deficit and revenue deficit would lead to the fall in the GDP. The fourth-quarter(Q4) GDP result of India has been recorded at around 3.2%.[9] This could lead to a downgrade of India’s sovereign credit score.

Credit Rating Agencies have played a vital role in the International Market.[10] A study which examined the impact of the credit agencies on the financial market found a significant impact on the size and levity in case rating is downgraded or negative.[11] Decreasing credit rating denotes the increased likelihood of the borrowers defaulting on the obligation and the creditworthiness of an entire nation.[12] The effect of Sovereign downgrade is positively affected by the outflow of the capital from the downgraded country.[13]Decreasing SCR has major implications on the economy the result of which is the creditworthiness of low rated countries as per the Credit rating agencies have a negative impact on the country having low grade in contract to the country having higher grade or rating[14]. The Credit Rating agencies have a huge impact on the modern financial chain, thus investors who rely on such rating receive benefit from the reduced informational box and the monetary cost associated while determining the creditworthiness of the issuer agency[15].


As stated above, ratings given by Credit rating agencies are based on the total health of the economy and the state of affairs of the finances handled by the government. Such decrease in the rating means that the bonds issued under the name of Government of India are more “perilous” than before because such degradation in ratings determines the government inabilities to return the amount.

Further, the government has to raise debt at a higher rate of interest. The lower risk imparts the government or companies to do the same at the lower rate of interest. Now, the situation is worsened for the Government and Indian companies because the investors around the world see such investment as a higher risk deal than before.

Therefore, obtaining a good SCR is important for a developing country like India to maintain its trade and economy.


[1] Marwan Elkhoury, ‘Credit Rating Agencies and Their Potential Impact on Developing Countries’(2008) UNCTAD (2008) https://unctad.org/en/docs/osgdp20081_en.pdf [2] Dr.Y.V.Reddy, Credit Rating : Changing Perspectives , Osmania University Arts College Seminar, Hyderabad (2000), <https://www.rbi.org.in/scripts/BS_SpeechesView.aspx?Id=50#:~:text=India%20has%20been%20assigned%20sovereign,with%20an%20investment%20grade%20rating.> [3] Rating Action: Moody's Downgrades India's Ratings To Baa3, Maintains Negative Outlook, THE MOODY’S (1 June 2020) https://www.moodys.com/research/Moodys-downgrades-Indias-ratings-to-Baa3-maintains-negative-outlookPR_424605#:~:text=New%20York%2C%20June%2001%2C%202020,ratings%20to%20Baa3%20from%20Baa2.&text=The%20long%2Dterm%20local%20currency,lowered%20to%20A2%20from%20A1 [4] Ruud Meeuwissen, The Effect Of Sovereign Credit Ratings On The Domestic Loan Supply Tilburg School of Economics and Management (2014) http://arno.uvt.nl/show.cgi?fid=135373 [5] Peilin Cai , Suk-Joong Kim and Quan Gan, The Effects Of Sovereign Credit Rating On Foreign Direct Investment The University of Sydney Business School (2006) https://www.business.uwa.edu.au/__data/assets/pdf_file/0007/2938084/The-effect-of-sovereign-credit-rating-on-FDI.pdf [6] Ibid [7] Numbers of the Edge: Assessing India’s Fiscal Response to COVID-19, Cbg India (2020) https://www.cbgaindia.org/wp-content/uploads/2020/05/Numbers-on-the-Edge-Indias-Fiscal-Response-to-COVID-19.pdf [8] Stimulus Package Not Sufficient, Opine 44% MSME’s: Survey The Banking and Business, (29 May 2020) https://bfsi.eletsonline.com/stimulus-package-not-sufficient-opine-44-msmes-survey/ [9] India's GDP grows 3.1% in fourth quarter, 4.2% in FY20, The week, (2020) https://www.theweek.in/news/biz-tech/2020/05/29/indias-gdp-grows-31-in-fourth-quarter-42-in-fy20.html [10] Masood O, Bashir F and Sahi AI, Sovereign Credit Rating Changes and its Impact on Financial Markets of Europe During Debt Crisis Period (Greece, Ireland) 6 Journal of Business & Financial Affairs (2017) https://www.hilarispublisher.com/open-access/sovereign-credit-rating-changes-and-its-impact-on-financial-marketsof-europe-during-debt-crisis-period-greece-ireland-2167-0234-1000304.pdf [11] Brooks R, Fatt RW, Hiller D and Hillier J, The National Market Impact Of Sovereign Rating Changes, 28 Journal of Banking & Finance (2004) https://doi.org/10.1016/S0378-4266(02)00406-5 [12] Masood O, Bashir F and Sahi AI, Sovereign Credit Rating Changes and its Impact on Financial Markets of Europe During Debt Crisis Period (Greece, Ireland) 6 Journal of Business & Financial Affairs (2017) <https://www.hilarispublisher.com/open-access/sovereign-credit-rating-changes-and-its-impact-on-financial-marketsof-europe-during-debt-crisis-period-greece-ireland-2167-0234-1000304.pdf [13] Amar Gande and David Parsley, Sovereign Credit Ratings and International Portfolio Flows, Vanderbilt University (2004) https://www.imf.org/external/np/seminars/eng/2004/ecbimf/pdf/parsle.pdf [14] Periklis Boumparis, Costas Milas and Theodore Panagiotidis, Economic policy uncertainty and sovereign credit rating decisions: Panel quantile evidence for the Eurozone, 79, Journal of International Money and Finance, 39-71 (2017) https://doi.org/10.1016/j.jimonfin.2017.08.007 [15] The World Bank Group, Credit Rating Agencies, World Bank Public Policy Journal (2009) http://docshare01.docshare.tips/files/23967/239677724.pdf, http://rru.worldbank.org/PublicPolicyJournal


BIBLIOGRAPHY


Journals:

1) Masood O, Bashir F and Sahi AI, Sovereign Credit Rating Changes and its Impact on Financial Markets of Europe During Debt Crisis Period (Greece, Ireland) 6 Journal of Business & Financial Affairs (2017) https://www.hilarispublisher.com/open-access/sovereign-credit-rating-changes-and-its-impact-on-financial-marketsof-europe-during-debt-crisis-period-greece-ireland-2167-0234-1000304.pdf

2) Brooks R, Fatt RW, Hiller D and Hillier J, The National Market Impact Of Sovereign Rating Changes, 28 Journal of Banking & Finance (2004) https://doi.org/10.1016/S0378-4266(02)00406-5

3) Periklis Boumparis, Costas Milas and Theodore Panagiotidis, Economic policy uncertainty and sovereign credit rating decisions: Panel quantile evidence for the Eurozone, 79, Journal of International Money and Finance, 39-71 (2017) https://doi.org/10.1016/j.jimonfin.2017.08.007

4) The World Bank Group, Credit Rating Agencies, World Bank Public Policy Journal (2009) http://docshare01.docshare.tips/files/23967/239677724.pdf, http://rru.worldbank.org/PublicPolicyJournal


Articles:


1) Marwan Elkhoury, ‘Credit Rating Agencies and Their Potential Impact on Developing Countries’(2008) UNCTAD (2008) https://unctad.org/en/docs/osgdp20081_en.pdf

2) Dr.Y.V.Reddy, Credit Rating : Changing Perspectives , Osmania University Arts College Seminar, Hyderabad (2000), <https://www.rbi.org.in/scripts/BS_SpeechesView.aspx?Id=50#:~:text=India%20has%20been%20assigned%20sovereign,with%20an%20investment%20grade%20rating.>

3) Rating Action: Moody's Downgrades India's Ratings To Baa3, Maintains Negative Outlook, THE MOODY’S (1 June 2020) https://www.moodys.com/research/Moodys-downgrades-Indias-ratings-to-Baa3-maintains-negative-outlookPR_424605#:~:text=New%20York%2C%20June%2001%2C%202020,ratings%20to%20Baa3%20from%20Baa2.&text=The%20long%2Dterm%20local%20currency,lowered%20to%20A2%20from%20A1

4) Ruud Meeuwissen, The Effect Of Sovereign Credit Ratings On The Domestic Loan Supply Tilburg School of Economics and Management (2014) http://arno.uvt.nl/show.cgi?fid=135373

5) Peilin Cai , Suk-Joong Kim and Quan Gan, The Effects Of Sovereign Credit Rating On Foreign Direct Investment The University of Sydney Business School (2006) https://www.business.uwa.edu.au/__data/assets/pdf_file/0007/2938084/The-effect-of-sovereign-credit-rating-on-FDI.pdf

6) Numbers of the Edge: Assessing India’s Fiscal Response to COVID-19, Cbg India (2020) https://www.cbgaindia.org/wp-content/uploads/2020/05/Numbers-on-the-Edge-Indias-Fiscal-Response-to-COVID-19.pdf

7) Stimulus Package Not Sufficient, Opine 44% MSME’s: Survey The Banking and Business, (29 May 2020) https://bfsi.eletsonline.com/stimulus-package-not-sufficient-opine-44-msmes-survey/

8) India's GDP grows 3.1% in fourth quarter, 4.2% in FY20, The week, (2020) https://www.theweek.in/news/biz-tech/2020/05/29/indias-gdp-grows-31-in-fourth-quarter-42-in-fy20.html

9) Amar Gande and David Parsley, Sovereign Credit Ratings and International Portfolio Flows, Vanderbilt University (2004) https://www.imf.org/external/np/seminars/eng/2004/ecbimf/pdf/parsle.pdf


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