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Introspect over Irrational Exuberance over Moody's Mood Swing

NOVEMBER 22, 2017

By Naresh Minocha, Consulting Editor

MOODY's upgrade of India's sovereign ratings is serving as a super-booster dose for National Democratic Alliance (NDA).

Moody's Investors Service (MIS) upgrade release has prompted Finance Minister Arun Jaitley to ridicule and admonish critics of Modi Government's economic governance. He stated: "Many who had doubts in their minds about India's (economic) reform process would need to now seriously introspect on their thinking".

Modi Government and BJP also ought to introspect over this juvenile flaunt of dubious certificate. They should know there are also other such certificates that might freeze them in their zero-gravity track, if not leave them red-faced.

A case in point is civil unrest that can drag economic growth and put off potential investors. The UK-based global risks observer, Verisk Maplecroft, ranked India 4th after Syria, Yemen and Libya on its civil unrest index released during August 2016.

According to Maplecroft, "it is striking that Brazil, France, India , Mexico and South Africa, which have all witnessed substantial disorder in the last year, lack adequate structures to avoid grievances escalating into wholesale protests".

Recall how angrily the Government had officially dismissed a report from Moody Analytics (MA)during November 2015 that cautioned the Government against hurting minorities in India. MA and MIS are two arms of Moody's Corporation.

MIS also ought to ponder over itsshallow home-work that led it to issue the upgrade at time when GDP growth is falling, fiscal opacityis shinning and corporate loan defaults are alarming. If MIS believes its depth and quality of research is good, then it should release the entire report on credit upgrade to the public.

Before elaborating on facts overlooked in grant of upgrade and subsequent jubilation in NDA, a brief recapitulation of what Moody's has decided and the ratings business would be in order.

On 16th November 2017, Moody's upgraded local and foreign currency issuer ratings to Baa2 from Baa3 and changed the outlook on the rating to stable from positive. There are eight more ranks above the revised rating.

The revised rating implies reasonable creditworthiness of Indian Government, which has never borrowed money from foreign markets apparently because it lacks courage to make mandatory disclosures. The Government-owned public enterprises, however, resort to external commercial borrowings (ECBs).

MIC has also upgraded India's local currency senior unsecured rating to Baa2 from Baa3 and its short-term local currency rating to P-2 from P-3. A day later, MIS upgraded credit rating of four Indian banks & financial institutions.

All the four banks and several other companies have raised ECBs in the recent past. The upgrade would thus have little impact on Indian economy which is groaning under the burden of over-leveraged companies.

MIS release says: "decision to upgrade the ratings is underpinned by Moody's expectation that continued progress on economic and institutional reforms will, over time, enhance India's high growth potential and its large and stable financing base for government debt, and will likely contribute to a gradual decline in the general government debt burden over the medium term".

Moody's has exuded confidence on the basis of distorted perception about reforms prospects and their impact. It states: "Government efforts to reduce corruption, formalize economic activity and improve tax collection and administration, including through demonetization and GST, both illustrate and should contribute to the further strengthening of India's institutions. On the fiscal front, efforts to improve transparency and accountability, including through adoption of a new Fiscal Responsibility and Budget Management (FRBM) Act, are expected to enhance India's fiscal policy framework and strengthen policy credibility ".

Recollection of unpleasant facts on these counts a bit later might swing Moody's mood from exuberance to despondency about Modi Government.

Rating business is judgemental. It is perception based on chosen facts. The problem is that no rating methodology factors in all vital facts especially the shocking ones that require research and reflect the ground reality.

As put by Panayotis Gavras, a top official of Black Sea Trade and Development Bank, in March 2012, "Even if a rating agency enjoys an excellent track record, the credibility of the regulatory process risks erosion because ratings are inherently fallible; they depend on judgments ".

The 2008 global meltdown saw how the three big credit rating agencies proved wrong in their country-specific ratings. Both international and national regulators have since then taken initiatives to tighten regulation of credit rating agencies and reduce dependence on them.

Modi Government should have also paid heed to ‘Principles for Reducing Reliance on CRA (credit rating agency) Ratings' laid in October 2010 by Financial Stability Board (FSB), a global regulator of which India is a member.

As put by FSB principles,"Standard setters and authorities should develop alternative definitions of creditworthiness and market participants should enhance their risk management capabilities as appropriate to enable these alternative provisions to be introduced".

In the business of credit rating, the other major global rating entities are Standard & Poor's and Fitch. Japan Credit Rating Agency, which also gives India's ratings, is emerging global player.

Apart from these, there are several entities that prepare global and country risk reports that include debt repayment default risks. In addition to these, we have entities that prepare governance indices or issue or subject specific indices.

Thus, MIS upgrade for India's sovereign ratings should at best be seen as a mere flash in a messy pan.

Did Moody's reckon on all data about fiscal laxity in India? Does it know how many times fiscal and revenue deficit targets under Fiscal Responsibility and Budget Management (FRBM) Act have been altered by successive regimes? Did it, for instance, reckon Comptroller and Auditor General's (CAG's) concerns.

CAG, in its latest available report on Financial Audit of Union Government Accounts released on 16th December 2016, concluded: total liability at current exchange rate as percentage of GDP has increased from 46.25 per cent in 2014-15 to 47.31 per cent in 2015-16.

This debt stock is thus way above the 43.60% recommended by the 14th Finance Commission (FC) for 2015-16. CAG also found that the liability towards depositors in small savings, provident fund etc. is understated by Rs. 7,18,404 crore. If this added to debt stock, then the government's total liability increases to 52.60 per cent of the GDP in 2015-16.

Finance Ministry pegged revenue deficit target for 2017-18 at 1.9% of GDP, against 1.79% recommended by FC. Similarly, it has fixed fiscal deficit at 3.2% of GDP as against 3% recommended by FC and accepted by the Government under revised FRBM Act.

Like CAG, International Monetary Fund (IMF) has flagged the issue of under-estimating fiscal deficit in February 2017. IMF's Staff Report (SR) on India noted: "The FY2016/17 Budget targets a fiscal deficit of 3.5 percent of GDP (equivalent to about 3.8 percent of GDP in IMF terms)".

It added: "public debt as a share of GDP is projected to remain at almost 70 percent by end-FY2016/17, and will decline gradually over the medium term, remaining above India's debt tolerance range (60–65 percent of GDP) for several years."

The Government might again do ‘creative accounting' of fiscal deficit by keeping bonds for recapitalization of public sector banks out of the purview of deficit.

Finance Ministry had last year directed certain public sector non-banking finance companies (NBFCs) and National Bank for Agriculture and Rural Development (NABARD) to raise money through a new instrument named ‘GOI fully serviced bonds' (GFSBs), which are apparently out of the ambit of fiscal deficit.

Yet another factor that should have led Moody's to defer taking a call on rating upgrade is Government's indecisiveness FRBM Review Committee that submitted its report in January 2017.

MIS should know that India fares poorly in IMF's Fiscal Rules at Glace (FRG) released during February 2017. FRG is compilation of fiscal rules of 96 countries assesses fiscal rules against certain four major parameters. India continues to avoid forming an independent fiscal council, an idea that has already been followed by 39 countries to improve their fiscal transparency and accountability.

MIS should also refer to FSB's ‘Peer Review of India' published in August 2016. The Review says: "There is at present no single authority or body that is explicitly tasked with macro prudential policy for the financial system as a whole. The FSDC(Financial Stability and Development Council) is a forum for enhancing inter-agency coordination for financial stability, but it does not have legal underpinnings and has a broader mandate that includes financial sector development and inclusion. Setting regulatory policy is done by individual regulatory authorities".

It adds: "The authorities should consider enhancing public communication on macroprudential policies, including through more detailed press releases of the outcome of FSDC/FSDC-SC meetings and greater use of the FSR to explain macroprudential policy decisions. In addition, the authorities should consider issuing a comprehensive periodic (e.g. annual) report or summary on the FSDC's activities ".

These instances should convince MIS that Modi Government is shunning core reforms including direct taxes code and national employment policy. It prefers to make more noise on whatever little it has done.

What applies to fiscal transparency equally well applies to anti-corruption initiatives. Modi Government has not constituted Lokpal even after rap on its knuckles by the Supreme Court. It has not enforced Whistle Blowers Protection Act (WBPA), 2014.

It has not reintroduced lapsed anti-bribery bills in Parliament. These are: Prevention of Bribery of Foreign Public Officials and Officials of Public International Organizations Bill, 2011,Right of Citizens for Time Bound Delivery of Goods and Services and Redressal of their Grievances Bill, 2011, the Electronic Delivery of Services Bill, 2011, The Public Procurement Bill, 2012.

It is small wonder then that the Modi Government is extremely stingy when it comes to disclosing to United Nations what anti-corruption reforms it has undertaken.

Let Moody's Analytics do more research on Modi Government's underbelly and produced a holistic report on reforms that the Government has avoided so far. Such a report would help counter-balance unwarranted jubilations over upgrade issued by MIS.