By Devanshee Dave
The recent meeting between Indias Prime Minister Narendra Modi and Russian President Vladimir Putin for the 18th India-Russia Summit will prove to be a milestone for encountering the prejudiced credit rating system of the top three US based rating agencies, namely Moodys, Standard & Poor’s (S&P) and Fitch. Both the countries have decided to back the development of a new credit rating agency which would be independent of all political conjecture and will dispel the biased boon given to the US and China. This will, in turn, give a better view of the economic position of all the countries.
Partiality in ratings is not new
In the 8th BRICS Summit which was held in 2015, the notion of a new rating agency was put forward which was backed by all the BRICS nations and now India and Russia have put their trust on the same idea by announcing the establishment of this new rating agency.
Last year, India was given a credit rating of Baa3, the lowest rating for debt-considered investment, by Moodys. Indian Finance Minister Arun Jaitley questioned the rating but failed to get a better credit rating. Even S&P washed away the chances of an upgrade in ratings citing Indias low per-capita GDP and higher fiscal deficit. Moreover, the credit ratings of Russia (Ba1 by Moodys, BB+ by S&P, and BBB by Fitch) have not improved since January 2015.
Credit rating agencies succumb to political considerations
It is claimed that as the top three rating agencies are based in the United States, they are highly influenced by the political factors in giving ratings to the developing countries. At the time of US financial crisis in 2008, the US was given a rating of AAA, which was unjustifiable and this raised serious doubts over the authenticity of these rating systems.
As per Forbes, for the alleged involvement in the financial crisis, Moody’s has recently (in January 2017) agreed to pay $864 million ($437.5 million to the Department of Justice and $426.3 million would be split among the 21 US states and Washington DC). In the same manner, though S&P has denied any fraudulent activity on its part in the financial crisis of 2008, it has agreed to pay the amount of $1.4 billion.
The method of payment that these agencies use is Issuer Pay Model (IPM), where the agencies earn their fees when they provide ratings to the issuer (the company or financial organisation which is being rated). In return, the issuers can sell their highly valued financial products to the investors like state and union pension funds. Thus, quite ironically, the credibility of these credit rating agencies hangs in the air.
Will the new agency be any good?
On 1st June 2017, India and Russia gave a joint statement about the establishment of a new rating agency. However, there are some obstacles that can prevent it from coming out as a distinguished credit-rating agency.
The first hurdle is the difficulty in convincing the investors in the U.S. and the U.K., as till now, they are getting quite good ratings from the existing agencies based in the US and thus it is hard to make them accept the partiality of these agencies. As per an article published in The Conversation, this hurdle can be rooted out if the new agency adopts Investor Pays Model (IPM), where the agency will be paid through the investors and thus the transparency of the ratings would be undisputed.
The second issue is that most of the investors are currently using the top rating agencies as they are quite familiar and these investors have relied on them for a long time now. Thus, the new model and the new agency would find it difficult to attract them in the nascent stage as it will be considered as inexperienced. At last, the success of the new agency requires global subscription and influences to establish its credibility, which could take years.
An effort for the better
In the past, various countries have tried to set up their own rating agencies but none of them has come close to the US based ones. Like the CARE (Credit Analysis and Research Limited) of India which is doing well in the India but still has a mark to make at the global level. As the proposed new agency is backed by the BRICS nations, which have the likes of China and India in it, the chances are higher that it can compete with the top three agencies and with combined inputs, these countries can defeat the hindrances that strew the path of the new credit rating agency.
Featured image credits - Visual Hunt