The office of the Chief Economic Advisor in the Union finance ministry has called for urgent reforms to how major credit rating agencies function, saying that their reliance on subjective assessments makes them heavily loaded against developing countries.

In a collection of essays titled “Re-examining Narratives”, the finance ministry economists said that the three major credit rating agencies – Fitch, Moody’s and Standard and Poor’s – need to make their methodologies more transparent and that their ratings should be based on hard data.

“The rating of India remained static at BBB- during the last 15 years, despite it climbing the ladders from the 12th largest economy in the world in 2008 to the 5th largest in 2023, with the second-highest growth rate recorded during the period among all the comparator economies,” the office of the Chief Economic Advisor said.

A rating of BBB- is the lowest investment grade, and credit rating agencies consider anything below that as speculative grade. While an investment grade implies that the risk of defaulting on loans is low, a speculative grade signifies a high risk of default.

The economists, in an essay titled “Understanding a Sovereign’s Willingness to Pay Back: A Review of Credit Rating Methodologies”, said that this has serious implications for developing countries’ access to capital markets and their ability to borrow at affordable rates.

In the same essay, the finance ministry economists said that a 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”.

They said that the three credit rating agencies fail to clearly distinguish between the indicators used to estimate the “ability to pay” and the “willingness to pay”. This complicates the evaluation of the assigned credit ratings.

The essay said that the agencies should rely mainly on a country’s history of debt repayment, rather than qualitative factors, in order to assess its willingness to pay back loans. “Thus, a nation that has not defaulted throughout its external debt history and through the vicissitudes of its socio-economic development should be taken as fool-proof in its ‘willingness to pay’ back,” it said.

The economists said that Fitch “ignores the welfare and development functions that public sector banks tend to play in a developing country” and fails to note that government-owned banks play an important role in promoting financial inclusion.

On Moody’s, the essay said that the agency is opaque about its dynamic weights and how it uses them to arrive at ratings. “Fitch mentions that weights used in their model are only for illustrative purposes,” the essay noted.

The economists said that Standard and Poor’s fails to clarify the weightage given to various factors as per its methodology.

“...Hence, one is left with no option but to rely on educated guesses,” they said. “Further, one must hunt through the various linked documents to understand how the score for each factor is estimated.”