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Tuesday, May 1, 2012

The Irrelevance of S&P Ratings

India’s sovereign credit rating was downgraded recently to BBB- by elite rating agency S&P. S&P also threatened to move India to category of junk rated countries. The stock bourses pretty much ignored this threat and continued with business as usual without any anxiety or crash whatsoever. Market and Price are best rating judges of a country or a business, and do not need an external agency to certify its credit or solvency status. In this article we try to look deeper within S&P’s ratings and its history and figure out if such rating agencies are relevant at all or they have reached a permanent state of irrelevance and obsolescence for investors and traders.

S&P (and other rating agencies) credibility took a huge hit in 2008 when several of highly rated AAA sub-prime investments went underwater and investors look helplessly as their investments in AAA rated paper turned junk very quickly. The Inquiry Commissions setup to look into 2008 subprime crash reported that: "The three credit rating agencies (S&P included) were key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval. Investors relied on them, often blindly. This crisis could not have happened without the rating agencies. Their ratings helped the market soar and their downgrades through 2007 and 2008 wreaked havoc across markets and firms.”

The 2008 crisis could not have happened without expert AAA ratings on subprime paper by rating agencies S&P, Moody and likes. Investors relied on their ratings in 2008 and lost all their savings when the AAA investments actually turned to be junk. It will take a lot of effort and time to erase this reality from public’s memory. That’s precisely the reason agencies are trying to now look pro-active and actively downgrading countries like India, though their credibility is hit so badly that markets do not take their ratings seriously anymore.

To take another data point, please look at countries which are currently ahead of India in S&P ratings:
India’s credit rating by S&P is currently below countries like Spain and Ireland. S&P’s India rating on local currency long-term debt is BBB-, compared to the ‘BBB+’ of Spain and BBB+ of Ireland. While India’s gross external debt is 3 per cent of GDP, both Spain and Ireland are over 50 per cent in debt.

Both these European countries are severely affected due to the current debt crisis, which is putting all of Europe on the edge during much of 2010 and 2011. Currently these high rated countries are barely surviving on Central bank loans and its surprising to see how their ratings are better than India’s whose external debt is just about 3 percent of GDP.

Not just this, it’s surprising to see that smaller countries which cannot match trillion dollar GDP of India and its growth rate are much better rated than India. Sample this, Bermuda has S&P rating of AA-. Botswana is better than India with A- rating. Chile is at AA. Estonia is at AA-. Solvak and Slovenia are at A and A+ respectively. Even Trinidad and Tobago is a A rated country by S&P.

European counties are currently seeing a –ve growth rate and are in confirmed recession are at high ratings with France at AA+ and UK at AAA. Italy at center of current debt crisis is better than India at BBB+. Japan growing at 1% rate from last 20 years is at AA-. 

Its no wonder that no-one takes S&P and Moody seriously now-a-days. Probably smart investor should take a contra stance and start investing in a country just when S&P downgrades, because S&P might be so slow, wrong and irrelevant in their calculations that a smart investor can benefit from a changing trend. Investors have instead downgraded S&P and Moody to junk till they get their act back in shape.

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