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Decimal Digest
15 Feb 2017

The Analytical blind spots of Rating Agencies in Sovereign Rating Practice

The basis of the Sovereign Rating Practice is based on the Newtonian analysis of economy, as espoused by neoliberal economic theories, which does not consider the reflexivity between political and economic scenarios. The politics of creditworthiness plays a role in perpetuating logic of a one size fits all Neo-liberal capitalism. It does not acknowledge the role of complexity and culture in shaping differing versions of capitalism. The expert vs operational aspects of fiscal governance in an economy leads to change in how politics is established in the economy, in often unanticipated ways, affecting the debt sustainability in the economy.

The ratings by large global agencies reflect the outcome based on their evaluation methodologies till that time. As we have observed time and again, each failure to produce accurate forward looking ratings has led to them moving from observing only macroeconomic fundamentals to analyzing contingent liabilities, liquidity issues and instrument specific analysis. The common theme to each lesson learnt in crises are underestimation of some aspect of the economy which stems from the inability to have a holistic view arising from myriad micro interactions to chaotic macro outcome based on high sensitivity to initial conditions. Their methodology, which looks at a few hundred factors and removes the socio-economic context, is still an incomplete one, but is nonetheless used to price financial instruments.

Despite exhibiting pro cyclical behavior and failure on many occasions, these ratings are considered because of absence of alternatives. The narrative it provides can be countered only by provision of alternative data points to break the monopolistic control of information.

Hence, it is imperative for a few countries of importance to have their own national champion rating agency, which understands and considers the local economic, social, political, legal and institutional framework and builds a new macroeconomic framework based on mathematics that is valid for human affairs rather than that for inanimate objects where reflexivity does not matter.

India, accounting for just less than a fifth of the humanity, has made a gargantuan mistake by allowing its top rating agencies to be owned by foreign capital that has no understanding of and zero sensitivity to local requirements. What is more, the role of the state is very pronounced in the way rating agencies operate in some key countries, as shown by the ignominious firing of the CEO of a rating agency a few years ago, when it downgraded the rating of the country.

Hence, it is up to India to pitch its story to investors rather than depend on foreign agencies to fully consider India’s achievements.


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