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The cost of losing a 'B'

Last week, to the joy of the virtuous, Standard & Poor's lowered its rating on India's rupee debt to 'junk' status.

For those mystified by the methods of rating agencies, a debt status is classified between investment grade and junk.

Within this broad classification there are many sub-classifications. The optimum status is 'AAA' and then steadily by alphabetic progression and numeric signs, the grade status is lowered.

Indian sovereign debt had been graded as 'BBB-' (triple B minus); it is now lowered to 'BB+' (double B plus). The loss of a 'B' has shifted India's status in market terminology from an investment grade debt to junk grade debt.

These certifications by credit rating agencies are greatly valued by lazy lenders who do not have time or have too much money to bother about doing their own research.

In a 'free' market the interest rate charged on further borrowings depends to a great extent on the classification status of the borrower.

Thus the American government, the ultimate benchmark, will be able to raise funds for ten year bonds at the Treasury yield currently running at 3.63 per cent per annum whereas companies like General Motors, at the lower end of investment grade will pay twice as much as the ten year Treasury rate or about 7.2 per cent.

Fortunately for the US government the quality of their borrowing is not, as far as I am aware, ever questioned by rating agencies.

Mystical ratios like the percentage of overall debt to GDP are looked at and pointed out. These surrogate figures comfort or frighten the lender.

They also provide an opportunity for rating agencies to pour out inane and unanalysed comments on the performance of particular economies, with what purpose is unknown.

The success of credit agencies lies not in the veracity and quality of their comments but to the idleness of lending institutions that have to satisfy their own bureaucracies for the decisions they make.

If individual bank mangers are told that the interest to be charged 'BB' should be 1.0 per cent than 'BBB', a norm is established for the entire system. If a frustrated lender baulks at this he can be shown the door and told to go elsewhere only to find the same response.

No one is particularly interested in doing the analysis de novo once a respectable agency has expressed its opinion.

For the economic commentator however there is some need to penetrate the fog that credit agencies surround themselves with. Consider the rerating of India's debt status by Standard & Poor's.

Their Managing Director John Chambers (a name of admirable Anglo-Saxon origin) made a statement: "The local currency downgrade reflects the government's growing Indian rupee debt burden and its inability to staunch the financial weakening of the public sector. The government has been unable to contain its growing budget deficit expected to reach 6 per cent of GDP in the current fiscal year. As a result, the consolidated debt of the Central and state governments is estimated to exceed 80 per cent of GDP this year."

All these remarks are no doubt correct but what is their relevance to India's ability to pay-off her rupee debts? After all, the local debt that the government incurs is denominated in rupees.

The government has a monopoly on the quantity of money it prints. If it wanted to reduce its debt from 80 per cent to let us say an outlandish figure of 50 per cent, it could do so simply by paying off the lenders with freshly printed money.

Since the printed note is India's legal tender and every lender to the government is aware of this, the rupee debt must always be fully creditworthy. No lender can complain that the government had cheated him, because by buying a bond he contracts to be paid back in rupee notes.

This argument is surely obvious indeed. It was one of the points of view put forward by the Nobel Laureate Merton Miller when he said those who ran trade surpluses with the US were exchanging goods with promises to receive printed dollar bills and this was a highly profitable business for the United States.

Perhaps John Chambers disapproves of this rather facile safety valve that the Indian government could operate.

Further, he may consider such a grotesque increase in liquidity highly inflationary, but he like many others who have propounded the same argument, fails to show the connection from liquidity to price increase. Nor is it very clear that a rise in liquidity would be harmful.

Indeed if an increase in liquidity had only damaging effects that should have happened already. Indian commercial banks are already up to their ears with funds but apart from the government they seem to find no suitable borrower.

Commercial banks are lending far more to the government not because they must but simply because in the growing recession there are no other borrowers.

If it is S&P's contention that the government's borrowing is raising interest rates to unreasonably high levels, perhaps the Indian authorities should take this argument into consideration by printing more money to finance budget deficits.

That would cost the government nothing. Indeed it may be the best method for financing government expenditure but somehow I doubt that will win accolades from Standard & Poor's.

Sadly the credit rating agency though making profoundly pompous macroeconomic statements shows no basis for its economic arguments.

It is the imprecision of their assumptions that makes the S&P comment so irrelevant. In their simple method the agency has ignored the monopoly power of the government in its ability to pay off its debt.

Unlike General Motors who cannot pay off dollar debts by printing dollars, the Government of India is able to pay off its rupee debt by printing rupees. Bringing that factor into consideration, requires one to rate India's rupee debt as 'AAA'.

To avoid any misunderstanding let it be said at the outset that there is no aspect in this conclusion that either encourages or discourages the present Indian macroeconomic policy.

Such issues have to be debated at an altogether different macroeconomic level. The simple contention put forward here is that the rating system applied by credit agencies like S&P is nonsensical.

It is particularly to be condemned now because as the global recession picks up momentum, some inflationary policies may be highly desirable.

Orthodox economists who have for so long sat with the gods moralising against the folly of expansionists may be compelled to look at the history of the thirties as the other side of folly in economic policy making.

Credit agencies like S&P who have echoed the orthodox with less economic understanding may be advised to reconsider their systems of rating.

At present these systems are neither specific nor sound in economics. Berating official economic policy is an enjoyable exercise but hardly useful if it is not well conceived and positively harmful if done incompetently by a professional agency.

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