Rating the raters

S&P meets its comeuppance with US downgrade

Standard & Poor’s (S&P) may have been right to downgrade the United States sovereign credit rating from triple A to double A plus, on the grounds that the political risk of fiscal correction in the US had gone up. But S&P seems to have underestimated the political risk of taking such a bold professional view. It is one thing to downgrade an India or a Russia, or even an Iceland and an Ireland, but how could S&P hold a mirror to the US of A? Unheard of! So, off with his head! Everyone who knows anything about sovereign credit ratings and power politics will recognise that S&P President Deven Sharma’s decision to leave the organisation was occasioned by US anger at his forthrightness in downgrading that country’s government debt.

 

To be sure, there has always been an element of politics in sovereign ratings. When S&P, Moody’s and Fitch rate different countries, their analysts often do so with an eye to Washington, DC. America’s friends are generally treated more gently than America’s foes. S&P had no qualms about downgrading India rapidly in 1989-90, partly contributing to the balance of payments crisis that the country faced in 1990-91, because India was not a friend of the US at that time. As India’s friendship with the US waxed, S&P and other rating agencies began to take a more benign view of Indian macroeconomic management and “political risk”. Political risk assessment is a very political exercise! When S&P downgraded the US, it gave as much weight to hard economic numbers as to the less tangible problem of political management. The former is a technical issue, and even on that there are different credible views, but the latter is a matter of judgement. To be sure, such judgement calls are inherently risky, but S&P was never chastised in the past when it took such calls on the political risk associated with fiscal adjustment in other countries. This one, that too taken by a person of Indian origin, has angered many in the US. Even a distinguished radical economist like Paul Krugman hit out at S&P.

The so-called “$2 trillion error” for which S&P has been pilloried is based on a judgement call that S&P analysts took. If anything, it reflects differing views or assumptions by analysts in government as well as in rating agencies about public spending and other macroeconomic trends that would shape future US debt burden and the country’s ability to bear that burden. As S&P has pointed out, if spending growth is assumed to be low the net general government debt for the US is estimated to reach 79 per cent of the US gross domestic product (GDP) by 2015. However, assuming much higher rates of growth of public spending, S&P has estimated this to reach 81 per cent of GDP. By 2021, the relevant numbers would be 85 per cent and 93 per cent, depending on spending trends. The gap between the two projected debt levels by 2021 was estimated to be $2 trillion. What it means is that this is not an error but the painting of alternative scenarios. Who cares about facts when the message is so bleak in the run-up to an election? Little wonder then that the messenger had to go!