Why bother about sovereign ratings when corporate firms from the same country can garner a better rating, has been the constant refrain of many who ridiculed those obsessed with national ratings, especially since the East Asian crisis when the rating agencies failed to sufficiently warn about the meltdown forcing some of them to even rework the methodologies. The critics also point out that since the international rating agencies have relaxed the ?sovereign ceiling? rule which restricted corporate ratings below national sovereign ratings after 1997, countries can now safely choose to ignore the latter.
Though such an argument is factually true, what the proponents of this view choose to ignore is that such outlier?s only fail to hide the true burden especially for the not so blue blooded corporate firms. This is especially so in the case of countries like India that has lower rating levels as even a single notch decline in rating can raise the spread by 50 basis points annually. Studies have in fact shown that the impact is especially more severe on emerging market firms, particularly those dealing in non-tradable goods. What is worse in the current Indian scenario is that asymmetrical impact also comes into play?-sovereign downgrades have a much larger impact than an upgrade. In fact a recent study shows that in the post-1997 period, almost four fifths of the corporates rated received a rating below that of the sovereign while 15% received the same and only 5% received a higher rating. With Indian firms borrowing $ 29.9 billion from abroad last year, a 50 basis point increase in interest rate will roughly translate into additional interest costs of around Rs 650 crore, not an insignificant sum in these hard times.
Sovereign ratings have been for long a favourite target of anti globalisers the world over. In India too there was widespread acceptability to such views with even the Reserve Bank pointing to the drawback of the international rating system. In fact the RBI once even pointed out in the mid nineties that while rating agencies like Moodys and Standard and Poor agreed in 67% of the cases where sovereign ratings were AA or Aa the uniformity ratio came down to 56% in other investment grades and then fell down to as low as 29% in the case of sovereign ratings below investment grade, which was applicable to most developing countries like India at that time. In fact the RBI went so far as to even argue that the risk weight on any corporate firm should be purely on the basis of its financial strength and should not be linked to that of its sovereign.
However such an argument fails to merit any serious consideration as there are at least three different ways by which a sovereign rating will impact on corporate creditworthiness. For one, a sovereign default will have an impact on the whole domestic economy and the firms operating within them. Then there is the spillover affect on firms when a defaulting sovereign clamps down with measures that impact a firm?s ability to pay. The third source through which a sovereign rating can impact on the corporate is through administrative measures that a defaulting sovereign, or that hovering near a default, may choose to impose like capital controls. However, the central bank views have evolved over the years and it has played up in India?s improvement of ratings in more recent years.
However, to be fair the full impact of ratings on emerging markets is yet to be fully understood, as most data till the early nineties was limited to a dozen or so developed countries. Studies have, however, shown that the perceptions of sovereign creditworthiness are very fluid and that in 13 cases of sovereign default in recent years the ratings of these countries were closer to the investment grade than to default just a year prior to its actual occurrence. But one can safely say that such fluidity is unlikely in India?s case, with its relatively restricted financial markets and lax fiscal management, and where changes move at the glacial pace of a bygone era.
p.raghavan@expressindia.com
