India's Paradox: Fastest-Growing Economy with a Poor Credit Rating
India is not just the 5th largest economy in the world, but also the fastest-growing economy. Despite having zero default history, India’s credit rating in the world is so bad that we are rated below countries like Peru, the Philippines and even Kazakhstan! This is the reason why we are asked to pay 1000s of crores in extra interest and our foreign portfolio investment is heavily impacted. If we wish to keep moving in the right direction and scale up to become the world’s largest economy, it is essential for us to eradicate this obstacle before it topples us!
The objective of this article is to trace the reasons for India’s poor credit rating despite its growth and development.
The central idea is to examine the working of sovereign bonds. This includes understanding the impact of judgements by global credit rating agencies on the value of a country’s bonds. A comparison has been made between India’s sovereign ratings and those of countries with lower GDP and growth rates than India. Additionally, the flaws pointed out by India’s foreign ministry regarding these ratings have been highlighted, along with efforts being made to address them.
Understanding Credit Ratings: Their Importance and Impact.
Credit rating is the rating given to a particular country, which indicates whether there is any possibility of default. If a country can honour all its commitments, it would be AAA-rated. BBB is the lowest investment grade, and anything below that is treated as sub-investment. Credit ratings are of immense importance when borrowing through international markets.
To understand this, let us explore the concept of sovereign bonds. When the Indian government needs money for a project, they issue bonds. For example, if India wants to build a bridge that requires about Rs. 10,000 crores, India will issue a bond of a similar amount. This bond is split into 10 units of Rs. 1 crore each. When investors buy these units, they are essentially investing in the Indian government. In return, the government will pay interest every year. Let’s say the interest rate is 3% and the tenure is 20 years. Investors will receive Rs. 3 lakhs per annum as interest, and the government will return the principal at the end of 20 years. Trading of bonds in the secondary market is also possible.
The catch here is that if India’s global reputation declines—i.e., there are chances of default—the investor might sell the bond at a lower price in the secondary market out of fear that the principal might not be recovered. But how do we know if a sovereign bond is risky or not? This is where the West became opportunistic, giving themselves extraordinary leverage while putting us at an unfair disadvantage. This led to the rise of credit rating agencies like Moody’s, Fitch, and S&P Global.
Are India's Credit Ratings Justified? The answer is no!
Credit ratings map the probability of default and therefore reflect the willingness and ability of the borrower to meet its obligations. India’s willingness to pay is unquestionably demonstrated through its zero sovereign default history. Yet within the sovereign credit ratings cohort, India is rated much below expectation. As a result, India’s finance ministry is to make a case for higher sovereign rating. We have rejected the ratings given by the NY-based rating agencies and have decided to make a pitch to global rating agencies in the coming days for an upgrade in our sovereign rating. To affirm and argue, the finance ministry of India has also presented a paper citing graphs that present a correlation between some of the most fundamental economic parameters like GDP growth, inflation and current account balance and the average credit rating.
Let us take a look at one of them;
The graph below illustrates the stark disconnect between India’s GDP growth and its average credit rating.
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Here, the X-axis represents the GDP growth of a country and Y-axis represents the average credit ratings. As we can interpret, normally, countries having GDP growth of about 7.5% have an average rating of about 3.9 and countries having GDP growth nearing 2.5% have an average rating of about 2.9. Looking at India, we have had a growth rate of more than 6% and most countries that grew at 6% are shown to have an average rating between 3 to 4 but shockingly, India stands at just 1. This is the case of just one metric and the other graph shows similar results. If this is not discrimination, what is? We are way below the trend line despite having our fundamental parameters at par. On top of that, as stated earlier in this article, we have almost never defaulted loans.
Apart from this, there are other instances as well to show that we do have strong fundamentals. To cite a few, inflation is still at a manageable level, having remained below levels witnessed in some advanced economies. Moreover, Fiscal deficit has been easing and the centre is committed to reducing it further to 4.5% of GDP (from 6.4% in FY23) in FY26. The current account deficit (CAD) fears, too, have eased considerably now.
Aren’t Corruption and Debt Causes for India's Downgrade?
Yes, Corruption and debt are part of the picture. However, they are just two pieces in the larger and more complex evaluation. To speak of public debt, Indias Simply put, the downgrading of India is not just a â€now’ problem, it has been going on for about 2 decades, even when congress was ruling India. The discrimination of these credit rating agencies has been affecting us for 20 long years.
Inside the Rating Process: How Subjective Perceptions Skew India's Credit Rating
The credit rating agencies play the game of perceptions. Moody’s, one of the leading agencies, in its assessment criteria includes only 5 quantitative parameters and about 13 qualitative parameters which means only 5 of them can be measured using data and the rest 13 are left to be evaluated using expert perception. So, to say, 13 out of these 18 assessments are impacted by judgements and perceptions and this is why the problem persists. Do we even know about how these experts are selected or why are they the â€chosen ones’ to put forward their perceptions? No, this is something that is not revealed by the agencies which obviously shows lack of transparency. If they talk about numbers, we could easily argue with numbers, but if they talk about perceptions, the debate is useless!
A leading agency, Fitch, says that the weights given by them to various criterias are only for illustrative purposes which means that they have their grading system but they choose not to follow it.
Another big issue is that these credit agencies expect India to work like foreign countries. The rating says that a country will have more points if they have more foreign investment in their banks but in the case of India, public sector banks are of extreme importance. Public sector banks are the reason why every Indian has a bank account today and so it is not possible for India to stand up to these expectations because the government’s aim is to look at people’s welfare before policy formulation. Now, some might say that the US has the reserve currency benefit whichIndia does not. However, Peru or the Philippines neither have a better financial condition than India nor do they have a bigger financial market.Â
If we look at the 10 year bond yield of India, Peru and Philippines, while the bond yield of Peru(6.58%) and Philippines(6.3%) stand close to approximately 6.5%, India’s range is between 7% to 7.5%. Apart from this, we can also consider the fact that neither Peru nor the Philippines are even close to India’s population (in terms of human resources) and GDP growth. Even then, our rating is much worse than theirs.
Conclusion
To sum it all up, while India’s journey as a rapidly growing economy has been nothing short of remarkable, the paradox of its poor credit rating remains a formidable challenge. Despite strong economic fundamentals, manageable inflation, and a commitment to fiscal responsibility, India is still perceived as a higher-risk investment compared to smaller economies with less robust growth.
The issue at hand isn’t just economic but also systemic. The metrics used by global credit rating agencies, which often rely on the so-called â€subjective perceptions’ rather than objective data, place India at a disadvantage. These agencies, rooted in Western financial norms, fail to account for the unique structure and needs of India’s economy, leading to an unfair and biased assessment.
However, this is not an insurmountable obstacle. India must continue to assert its position on the global stage, pushing for greater transparency and fairness in the credit-rating process. By demanding a reassessment based on actual economic performance rather than outdated perceptions, India can work towards securing a rating that truly reflects its potential.
As we look to the future, the path forward involves not only challenging these biases but also creating a more equitable global financial system. India’s growth story is far from over, and with the right steps, it can pave the way for a new narrative — one where its true economic reality is portrayed and the nation’s potential is fully realised.