Rating method needs reform: Finance ministry paper – Times of India

NEW DELHI: Citing opaqueness in the rating methodologies of global agencies such as Moody’s, Fitch and Standard & Poor’s, a paper by officers in the finance ministry’s economic division has called for a reform of the mechanism for developing countries, which have to bear the adverse consequences.
“Reform in the credit rating process is the need of the hour.As the rated sovereign is obligated to be completely transparent, establishing symmetry of obligations warrants that the rating agencies make their processes transparent and avoid employing untenable judgements… Reforming the sovereign rating process will correctly reflect the default risk of developing economies, saving them billions in funding costs,” said the paper released on Thursday.
The concerns flagged were on three counts. One, not only were they called opaque but were also described as being disadvantaging developing countries. Pointing to Fitch’s methodology, the paper said that greater weight was assigned to foreign ownership of banks, which ignored the development role played by state-run entities.

Two, it said that the experts consulted by the agencies were selected in a non-transparent manner, “adding another layer of opaqueness to an already difficult-to-interpret methodology”.
Three, the government economists have argued that there was lack of clarity on the weights assigned for each parameter.
“Opaqueness and non-transparency in rating methodologies are fertile grounds for sowing suspicion about the discriminatory intent of CRAs, particularly when rating downgrades are mostly in respect to economically weaker nations… There is a strong feeling among the developing countries that subjective assessments tilt, most often, in favour of the advanced economies, as developing countries have borne the brunt of over 95% of all credit rating downgrades, despite experiencing economic contractions, which were milder than their advanced economy counterparts,” it said.
Between 2020 and 2022, over 56% of the African countries that are rated by at least one of the big three agencies were downgraded, compared with 9% of the European nations. Similarly, negative warning announcements such as reviews, watches and outlooks were linked to increase in the cost of borrowing for developing countries.
The review of the credit rating methodologies of the officials showed that there was considerable reliance on qualitative variables to capture ‘willingness to pay’. “The significant presence of qualitative factors in credit rating methodologies also gives rise to bandwagon effects and cognitive biases amply reflected in various studies, generating concerns about the credibility of credit ratings.”

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