Thursday, September 20, 2012

CRAs wake up Singh

This article was first published in the Free Press Journal on September 17th, 2012


Prime Minister, Dr. Manmohan Singh, the architect of India's liberalization policies and the person credited with ending the license raj, had slipped into oblivion in the last few years. He has been often criticized of being a puppet at the hands of Mrs. Sonia Gandhi, the President of UPA. Increasingly so in the past year when the Indian Economy has experienced a slowdown and loss of investors' confidence. Dr. Singh seems to have reincarnated himself in the light of the downgrade threats from Credit Rating Agencies (CRAs).

Empirical analysis of credit rating downgrades conclusively point towards a fall in benchmark indices across the world, by 0.3% to 1.2% on the day of the downgrade and the next day. Research also shows that the CRAs do provide new information to the market, and the information is especially significant in the case of downgrades.

However, the failure of CRAs to warn the investors of many a recent events (both at company as well as country levels), have raised questions on the worthiness of the CRAs itself. Marwan Elkhoury, Economist and Mathematician, writes in the Compendium on Debt Sustainability and Development (UN, 2009), "Ratings tend to be sticky, lagging markets, and then to over react when they do change. This over reaction may have aggravated financial crises in the recent past, contributing to financial instability and cross country contagion".

But the point of interest to us in India is the next line written by him, "Moreover, the actions of countries which strive to maintain their rating grades through tight macroeconomic policies may be counterproductive for long term investment and growth". To the credit of RBI, they have resisted any efforts of bowing out to the calls of a decrease in interest rates by the industry.

The UPA government though has bowed down to the fear of a credit rating downgrade, to junk status. They have announced a hike in Diesel prices and unleashed the reforms to bring in FDI in retail, aviation, power exchanges and broadcasting services.

The thing is, bowing down is not always bad. So the question is are these reforms really good for India? Are the reforms enough? Is it too little, too late? While a downgrade will have adverse impact on the stock market, FII inflows, credit and growth, the reforms announced will not have much of an impact if the entire ecosystem to do business is not made more favorable. Delays in projects due to multiple clearances required at the state and centre level and rampant corruption will only keep the investors at bay and push the exports, industrial output and GDP further down.

Dr. Singh, if you have really woken up from your slumber, go all out, leave no stones unturned. You do want to be remembered as the "Reformer" and not the "Underachiever"!
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