Credit Rating Downgrades: The emperor’s new clothes

Jayant Pai |

Different countries may have different (and often opposing) ideologies, economic systems and cultural/religious pursuits but if there is one thing which unites them all it is a ‘Credit Rating’ downgrade. 

Whenever a country experiences one, the reactions are fairly similar:

  • Denial: ‘We are not like that’ is the initial vehement denial. According to them, ugliness lies in the eyes of the beholder and the rating agencies are adamant on viewing a beautiful country as ugly.
  • Indignation: The ruling party/government’s first reaction is “How dare they do this?”, Such a reaction emanates from both, fast growing as well as slow growing countries but more so from the former. They feel outraged that the agencies are not according any premium to the ‘superlative growth numbers’ that they are consistently throwing up, and are unduly harping on a few seemingly trivial negatives such as excessive red tape, inflation, current account deficits, etc.
  • Self-righteousness: “Rater rate thyself”…is another common reaction. Countries who have been downgraded will cite how rating agencies were caught napping in the lead-up to the sub-prime mortgage crisis and the Lehman collapse in 2008, They will then imply that the agencies are not competent to judge others.
  • The media’s reaction: Newspapers and TV channels will indulge in a lot of jingoism and treat the downgrade as an attack on the country’s sovereignty. They will elicit the views of ‘experts’ who will usually shrilly denounce the event. More measured voices (often those with a counter-view) will be drowned in the din.
  • The corporate sector: They will go with popular sentiment and deride the downgrade. Some will go further to say that their country is an unwitting victim of another country or region’s economic travails.

Of course, all constituents have their own reasons behind such posturing:

For the Government, a virulent reaction is a means of self-defence and a convenient smokescreen, both, to hide its own shortcomings as well as to fend off the barbs of the Opposition.

For the media it is commercially safer to initially exploit the feeling of outrage and indulge in some sober analysis after a few days, once the furore subsides.

Corporates are one of the direct beneficiaries of being of a part of a country which is “The flavour of the season” as several doors open to them globally. They fear that a downgrade may result in reduced interest in their country which in turn may harm their own interests.

Besides, people from within a country are often vilified or sneered at whenever they hold up red flags. Hence there is greater incentive to remain silent and maintain the status quo rather than rock the boat.

Unfortunately for all opponents of such downgrades, global bond markets believe in and act based on credit ratings. This is because ratings provide a ready reference point to investors. Sure, it may be naive to solely rely on these ratings, but it is is equally silly to ignore them completely, This despite periodic murmurs that rating agencies are behind the curve, etc.

A downgrade often leads to a significant rise in borrowing costs whether it is for sovereign debt or corporate debt. That is why, once the dust settles after the grandstanding, countries begin seeing the writing on the wall and quietly begin the process of repairing their damaged rating.

While it is true that rating agencies are often not the ‘best’ arbiters of a country’s calibre, their relative global stature means that they can often play the role of the child in the story, who had the courage to shout out that the emperor had no clothes on….

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