THE mandarins of the economic establishment in the capital have gone ballistic. Euphoria is in the air. From the SEBI chairman to the Niti Ayog chief, all were ecstatic. Even Shakti Pada Das, the former ministry of economic affairs secretary who had only last year, vociferously protested against the Moody’s rating methodology, accepted the upgrade by the same agency with a rider; this ought to have been done earlier! But, the icing on the cake was obviously the finance minister Arun Jaitley’s ‘insightful’ claim “We welcome this upgrade, we believe that it is a belated recognition of all the positive steps which have been taken in India in the last few years.” It was a mixture of relief and bravado. What else would one expect? Of late, he was left in a spot in defending the otherwise defenseless position of the government on demonetisation and disastrous implementation of GST!

GENESIS OF THE RATING BUSINESS

At the beginning of the 20th century, there were no ratings agencies, and very few ways of telling which of the many emerging securities were worth investing in. There was a gap in the market, and the first person to fill it was a small time Wall Street minion John Moody. In 1900, aged 32, he published Moody's Manual of Industrial and Miscellaneous Securities, a compendium of information on thousands of financial institutions. The book sold out in months, and an industry was born. Poor's Publishing Company (the predecessor to S&P) emerged in 1916, Fitch in 1924.These big three today constitute the backbone of the rating industry.

Until the 1980s, the Big Three were still primarily North America-based, and demand for their services was not high. This was because they rated the debt markets, whereas at that time companies still did half their borrowing from banks, and invested in things in which they had personal knowledge. A leftwing economist Ha Joon Chang points out “Banks lent to companies that they knew or to local households, whose behaviour they could easily understand, even without individual knowledge and acquaintance. Most people bought financial products from companies and governments of their own countries in their own currencies.” But from the 80s onwards, as the financial system became more deregulated, with International Finance Capital driven massive financial flows, companies started borrowing more and more from the globalised debt markets, and so the opinion of the credit ratings agencies became increasingly relevant. Though all three big agencies are still headquartered in US, they now have presence in hundreds of countries.

With the rating industry having gone truly global, there were, however, two major problems. The methodology of assessing risks and more importantly, the funding of the industry; it was the clients; the corporate and sovereign entities who were being assessed were paying the industry. There is an obvious conflict of interest involved, as the ‘hand that feeds’ cannot be blemished!

The problem is that ratings agencies are funded by the very companies they rate. If you want to be rated, you must pay an agency between $1,500 and $2,500,000 for the privilege, depending on the size of your company. Both in theory and actual practice, this creates a conflict of interest; because it gives the agency an incentive to give the companies the rating they want. It could explain why, for much of the past decade, agencies seemed happy not to question either the risks banks were taking, or the accuracy of their accounts.

There is also tweaking by these rating agencies based on their own judgment of getting back money from the standpoint of their client. According to a report from Guardian –“The UK has a rating of AAA,” says Ms Moody. But then comes the hammer-blow: “We also have a negative outlook for the UK.” This negative outlook – isn't quite AA1, but it's the preamble to it. The lower their outlook, the more likely Moody’s think the UK government is to default on its debts – and the less likely it is that people such as me will want to lend it money. The lenders that do remain will be more nervous about the prospects of getting their money back – and so they’ll charge higher interest rates. And the higher the interest rates, the steeper the government's debt repayments, and the more likely it is to default. And so it goes on.

The very nature of their function highlights the paradoxical position ratings agencies find themselves in. Today, they are said to be too quick to downgrade government bonds. Five years ago, by contrast, they were too slow to downgrade the toxic debt that caused the financial crisis. “During the sub-prime mortgage crisis,” says Larry Elliott, the Guardian's economics editor, “the ratings agencies were very, very lax.”

The other important factor which facilitates distortion in the dependability of the findings of these ratings agencies is the extreme concentration, a general feature of contemporary finance capitalism. It is an example that highlights the power of the Big Three, who collectively rate around 95 per cent of debt. There are more than 150 ratings agencies worldwide, but in order to have any credibility, companies really need at least one of Moody's, S&P and Fitch on their side, and preferably all three. The first two firms each control around 40 per cent of the market. Fitch has about 15 per cent, and is usually engaged when S&P and Moody's disagree significantly about the creditworthiness of a debt. This generally happens because S&P measures how likely a debtor is to default, whereas Moody's rates how long the default is likely to last. Therefore, these big three often act as a cartel.

GLOBAL FINANCIAL MELTDOWN: FOCUS ON MOODY’S

The real critical focus on the rating agencies came in the wake of the financial meltdown. The problem posed by credit ratings agencies lies not only in their alleged malpractice or negligence, but in the sheer impossibility of rating creditworthiness in the first place. It is a problem that derives from the difference between quantifying risk and predicting uncertainty. 

But malpractices are galling. The two orders against Moody’s have starkly brought these to the fore. In the context of findings against Moody’s role, the agency itself recognised their folly in a settlement. “Moody’s failed to adhere to its own credit rating standards and fell short on its pledge of transparency in the run-up to the Great Recession,” said principal deputy associate attorney general Bill Baer.　

Apart from this, the European Union regulatory agency also slapped a penalty on the Moody’s in a separate case. The European Union’s markets regulator has fined Moody’s 1.24 million Euros ($1.4 million) for failing to give investors sufficient information about how ratings on major institutions such as the EU were compiled. The failures relate to 19 ratings issued between June 2011 and December 2013 for nine international bodies, including the European Investment Bank, the European Investment Fund, the European Stability Mechanism, the European Financial Stability Facility, and the European Union itself. Moody’s gave too little public information about how the ratings were arrived at, making it harder for investors to check and verify they were sound and reliable, ESMA said, adding that the only public information available was a press release.

VACUOUS AND PERVERSE CELEBRATION

By now, it must have become clear, what can be made out of these celebrations of official India! Not that that Modi, Jaitley, et al are unaware of these information which are very much in the public domain. But the imperative for deflecting attention from the mess that ails the Indian economy has become supreme. People have slowly but surely started to express their concerns, grievances and despair that they have come to face in real life. The farmers, the workers, small business and the millions who need to join the workforce all suffer from the misgovernance that they encounter on a daily basis. The polarisation of the people based on identity, intolerance ,violence, the growing attacks on women and misogyny all add up to uncertainty and strains on social cohesion.

Moody’s upgrade, even if it was with spotless credibility and transparency would only represent a speck in clearing the obstacles that plague the possibility of investment. It is only enhancing the purchasing power of the people and shoring up the aggregate demand that will make investment interested in the Indian story. Those conditions cannot be made unless the government comes out of this denial mode. Real achievements towards delivering on commitments and improving the lot of the people cannot be made through multicrore advertisements and empty sloganeering amplified by a domesticated mainstream media or the hired services of cyber brigades in the social media. That needs character! Ratings by dubious and fraudulent agencies like the Moody’s can create a false air of celebration; but that cannot stop the truth from exploding!