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"Broadly, in setting country ratings, we look at the intrinsic wealth of a country..." - Views on News from Equitymaster
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  • Mar 16, 2000

    "Broadly, in setting country ratings, we look at the intrinsic wealth of a country..."

    Kristin Lindow is a Vice President/Senior Credit Officer in the Sovereign Risk Unit at Moody's Investors Service. Ms. Lindow joined Moody's in 1993. She has been deeply involved in the expansion of Moody's country ratings throughout the developing world, in Latin America, Central and Eastern Europe, South Asia, and Africa. These ratings serve as a ceiling for the ratings that Moody's assigns to the foreign currency bonds issued by both public and private sector institutions in the individual countries. At present, she is the lead country analyst at Moody's for the ratings of India, South Africa, Greece, and Cyprus as well as a number of highly developed countries in northern and Western Europe. During the six years prior to joining Moody's, Ms. Lindow was a Senior Economist at the Institute of International Finance (IIF) in Washington, D.C., where she focused on the macroeconomic policies and external financing needs of Latin American countries. She spoke to us by telephone from her office in downtown New York City. Moody's recently purchased a stake in ICRA, a top Indian rating agency.

    In an interview to equitymaster.com, Ms. Lindow, Vice President/Senior Credit Officer, speaks about the impact of the new budget and the government's efforts on India's sovereign ratings

    EQM: What factors do you and your team members consider before making a rating judgment on a country?

    Ms. Lindow: Rating a country is a rather complex and lengthy process. I should clarify that we are a small but important niche within Moody's rating galaxy - we are only about 30 people doing sovereign ratings out of a total of 1,500 people that rate companies, banks, local governments, and structured finance transactions. Our sovereign rating group is tiny, but we leave a relatively large footprint across the Moody's organization because of the overall ceilings we set for the corporate ratings, particularly for ratings of international companies.

    Broadly, in setting country ratings we look at how economic decisions are made by the body politic; the intrinsic wealth of a country; how the distribution of income in a country feeds into the overall decision-making in the country and the building of a consensus at the highest policy-making levels; and the internal and external finances and debt levels of a country and its government.

    In India's case we have looked at the weaknesses in the public finances, shortcomings in infrastructure, and the difficulty that coalition governments have had to decide a comprehensive policy stance. In many other countries with coalition governments, we see more consensus as to where economic policy should be directed. India has a vibrant policy framework, which means it is always evolving and changing, but the strong influence of narrow local interests on policy makers means that the decisions that are taken are not always for the greater good of the country. This push-and-pull of vested interests often slows economic reforms, particularly at times when no sense of crisis prevails.

    From a global perspective, over recent years we have seen that our job of rating the world has become more mainstream, in the sense that economies are converging and there are fewer, and less frequent shocks to the global system. Even when the world economy experiences major shocks like the Asian and Russian crises, the recovery was relatively rapid for most of the countries affected as well as the rest of the world. In light of this experience in reference to other examples looking back over the last century, we believe that the impact of any shocks going forward may be transmitted quickly, but that the bounce back to equilibrium is likely to be equally rapid. Many economists would argue that the economic rules and interactions have not fundamentally changed and that the world will always have long cycles of economic ups and downs. Still, our sense is that the integration of the global financial markets and world economies implies that the shocks could be less frequent, perhaps temporarily deep, but more rapidly overcome.

    EQM: Is a debt rating a historic comment or a statement about the future?

    Ms. Lindow: A debt rating is meant to be forward-looking. Let me give you an example. In 1995 we assigned an initial rating to Poland at the lowest investment grade early in their reform process. They had just had massive debt forgiveness from bilateral and commercial bank creditors following repeated debt rescheduling, but we believed that this would not be the situation going forward given Poland's likely importance to Germany and the rest of Western Europe. That assessment proved to be remarkably accurate. Poland's debt burden continued to fall relative to their capacity to pay. Last year, we raised the rating by two notches. Our competitors were more cautious, and initially rated the country much lower, but we were able to differentiate Poland's past from its future and assign a rating that was more appropriate for the long term.

    EQM: What are the positives and negatives, from Moody's perspective, of the economic reform process over the past 10 years?

    Ms. Lindow: The positives clearly are the start of deregulation, de-licensing, oil pricing reforms, gradual removal of trade barriers, opening the financial markets to foreign competition - the latest being the insurance sector, the sale of PSU assets, the recognition of the economic constraints facing India are all important positives. The fact that coalition governments with different parties have now had a chance to be in government and understand the problems of the country, becoming more familiar with the issues that India has to address. Also, the breakdown of xenophobia, the desire to seek foreign capital and technology - the welcome mat being out for foreign direct investment - these barriers have fallen rather dramatically in recent years. Now you no longer have private or public sector interests so adamantly opposed to foreign involvement. There is recognition that India can only benefit from having access to foreign capital and expertise and this is now being reflected in the dynamism in the Indian private sector. Another important element is the strengthening of the banking system. Even though there is a long way to go to make the system more stable, the steps taken over the past eight years make the banking system more market-oriented. Also important has been the improvement of the risk assessment of loans and credit monitoring. These factors, among others, represent important positives in the country's overall reform agenda.

    The negatives, or shortcomings, of the reform agenda are so well known that it almost does not require restatement but nevertheless I will point out those most relevant to constraining India's rating. First and foremost is the inadequacy of fundamental public sector reform, which is needed to move the economy onto a higher growth path by freeing up resources for investment. Progress in this area is impeded by the lack of an exit policy as well as inflexible labour rules. I would emphasize that the rationalisation of the public sector involves more than just divestment or privatisation, which is why the spotlight has been cast so vividly recently on spending items such as subsidies, defense, and the cost of servicing the growing government debt. The pressures these exert relative to government resources mean that little is left over to meet the country's investment, social and educational priorities that would graduate more people out of poverty.

    In addition, trade and sectoral deregulation is still partial, so that India is unable to take full advantage of its enormous agricultural and industrial potential. Another negative is that while the legal system in India functions better than in a number of countries in the developing world, the legal processes are relatively cumbersome. This slow response time can be a major stumbling block for foreign investors wanting to enter the Indian market, not to mention Indian companies that want to modernise, whether public or private. All of these factors prevent India from being the dynamic force in the region that it naturally could be.

    Since ratings are a relative assessment of default risk, the lags behind other countries' progress - with respect to trade and capital liberalisation, economic diversification and modernisation, infrastructural deficiencies, clarity and timeliness of statistics - all of this is reflected in where India stands on our rating scale. Results matter. Broadly speaking, every country in the world is moving forward, so just making progress relative to where you were before is not necessarily sufficient to moving up the rating scale when others are progressing even faster.

    EQM: How does the reform process in India compare to those undertaken by other similar-sized economies like Brazil, Mexico, and China?

    Ms. Lindow: Ironically, some countries that are further along in the public sector reform process can be lower rated, because of other factors that raise their default risk, such as higher levels of debt. In India's case, an important consideration supporting the rating is the success of India's efforts to improve its external debt payments capacity since its serious balance of payments crisis in 1990/91. The country has moved away from reliance on external debt, with particular attention to avoiding short-term debt, so this has allowed the country to have a slower pace of reform without resulting in another external balance of payment crises.

    It is impossible to be precise about such judgments, but India's public sector reform effort is probably roughly on par with that of Brazil (rated significantly below India at B2). Brazil, like India, has a multi-party, relatively noisy democratic system that hasn't recorded steady progress on public sector reform and still has a long way to go, although the annual budget deficits are significantly smaller relative to GDP than India's. Nevertheless, Brazil is a lower-rated country because of our concerns about its heavy debt and debt service burdens. As for other examples, India could be said to be behind the public sector reforms seen in Mexico (which was just raised to investment grade Baa3 last week - two notches above India) and Argentina (rated B1, two notches below), but is arguably ahead of the public sector restructuring in China, especially in the banking sector.

    Although India has reduced the threat of another external crisis by lowering its external debt and debt service burden, India has not been able to increase its share in the global export market in spite of intermittently rapid bursts of export growth. China, on the other hand, has allowed its special economic zones to create a dynamic export base and this has resulted in a larger Chinese share in global trade. India has US$ 100 billion in foreign debt compared to China's US$ 150 billion in foreign debt, but India's economy is less than half the size of China's economy and China has considerably larger foreign assets. Hence, China is considered to be in a stronger external position than India. China's foreign currency country ceiling is A3 and India's is Ba2 - that is, 5 notches apart.

    The lowest investment grade is Baa3: India is rated 2 notches below investment grade and China is well into the investment grade category. I should emphasize, however, that many credits in China, including some of its state financial institutions, are rated much lower than the country ceiling.

    India was Baa3 (investment grade) until about 2 years ago. We lowered the rating due to the volatile political situation, the heightening of regional tensions, the lack of progress on reforms, and the worsening external situation with exports going nowhere and capital account financing being affected by the withdrawal of aid money after the nuclear tests. It was no coincidence that we were seeing the first signs of increase in the debt ratios for India since the balance of payments crisis.

    EQM: Your views on the recent budget in India?

    Ms. Lindow: It was essentially in line with what we expected in terms of acknowledging the past year's worsening fiscal results. Obviously, last year's budgeted revenues and expenditures were not going to be met as a result of higher expenditures at the state level, the Kargil conflict, and election-related expenses. All of this spending was not being offset by employee downsizing as advocated by the Fifth Pay Commission when they advocated increasing salaries of government staff three years ago.

    But what we did expect and did not see in the new budget was more aggressive spending restraint, a more significant withdrawal of subsidies, the actual elimination of some jobs in the public sector, and concrete proposals for spending cuts that were being hinted at months before the budget. That was not forthcoming. We were disappointed and surprised. At the same time, however, we recognize that the nature of the political decision making in a coalition - with so many different interests - could lead to internal dissent over tough decisions. Even those cuts in spending that have been proposed are facing lots of opposition from within the coalition. Whether or not the government backs down will be an interesting statement of what we can expect for the rest of the term.

    EQM: Do you expect the government to last the full term?

    Ms. Lindow: We think this government has a longer shelf life: we judged that it could last for at least 3 years out of its 5-year term when we changed the outlook from stable to positive in October 1999. We don't believe it is in the interest of the other coalition partners to bring this government down. One cannot read the minds of everyone involved, however. After the results of the recent state elections, some politicians may feel they can exert more influence in a different political configuration, although I reiterate that we assess that likelihood to be relatively low.

    EQM: Your wish list for what the Government of India should do.....

    Ms. Lindow: Our perspective is that the ratings are just an objective statement about what we see. We very much try to avoid saying what we would like to happen because it may suggest that if those things happen, it would have a direct ratings impact. We are not in the business of giving advice - that is up to the government's advisors and bankers. We merely report our assessment in the form of our ratings of what is done policy-wise and the situation that the country confronts.

    EQM: President Bill Clinton is visiting India on March 20th. Your predictions on the effect of his visit?

    Ms. Lindow: It is an important statement about India's position in the world at the present point in time. For better or for worse, India's nuclear tests in May 1998 did raise India's visibility on people's radar screens. One may assess that it is dangerous from the standpoint of regional tensions and I personally think it has created enormous problems from that perspective. I also think the nuclear arms race will be very costly in the long term for India as well as Pakistan. But, purely on the basis of raising its profile, India has become much more important to the USA.

    Aside from the effort to get India to sign the Test Ban Treaty, the President is recognizing the linkages that exist between the two countries that have largely been ignored by previous administrations in the USA. We have in the USA a large number of non-resident Indians, and they are increasingly influential and that has not been properly recognized previously and I think that is also what the President is trying to acknowledge.

    Given that President Clinton is only a few months from leaving office, however, I don't know if we can expect any substantial change after this visit. The visit is more a gesture of friendship between the countries and the hope is that there will be more high-level interaction between the two countries in the future.

    EQM: Does being a democracy have any weightage in this day and age or do Indian policy makers fool themselves on the importance of "being a democracy" when negotiating business deals with other countries?

    Ms. Lindow: Given India's large size and diversity, a democracy seems best suited for the country. India is evolving from a one-party system that was in place for a very long time to this multi-party system with lots of local interests being represented - it will take some time for the noise of that evolution to settle down to more effective policy making. That does not mean that India is not progressing. As an admirer of India, I don't like the analogy of the elephant and the tiger used by policy makers as it puts India on a bad light. The lack of rapid policy actions has resulted in India having lower levels of literacy, lower standards of living, and lower levels of infrastructure than a lot of its Asian neighbours. All this serves to retard India's progress, at least in a relative sense. It becomes a complicated catch-22 situation where you can't progress rapidly because you don't have the infrastructure, and you can't have the infrastructure because you don't have the financial resources. In the meantime, other countries continue to move forward.

    I think India is at a potentially major turning point because of what I mentioned before: the broad experience of all of the political parties who have now know the realities of being in government, as well as the recognition of the importance of welcoming foreign capital and expertise. There are clear signs that India is at a new juncture with respect to its future growth prospects and it will be very important to seize this opportunity. In this context, we see the relatively unambitious attempt to seize control of the fiscal problem and the heightened tensions with Pakistan as worrying. As to the latter, although both sides are to blame, the initial nuclear tests by India have exacerbated the problem. So despite the promise, there remain impediments that could stand in the way of India taking its historic opportunity.

    EQM: What is your view of the "new economy", and India's potential in this field?

    Ms. Lindow: You hear a lot in the United States and in Japan on this issue. The dissection of the economy into old and new is becoming more focused. What I think the new economy does offer in India and is tremendous promise for young people. In India, as in many countries, there is tremendous segregation of opportunities. Look at how difficult it is to get into the best schools. Now the new technology offers an opportunity to younger people to go into these fields and still be very successful regardless of whether they are able to get into the best schools. From that point of view, it may be the kind of stimulus that India needs to insert itself into a higher growth path. It certainly represents a prospect for India to be an integral player in the high tech revolution.

    EQM: Any comments on the valuations of this "new economy" and the stocks of the "new economy"?

    Ms. Lindow: Hmmmm. That is not my field.

    EQM: Have you rated the debt of Amazon whose market cap at one time was 85% of that of India's GDP?

    Ms. Lindow: Yes we have rated the debt of Amazon and it is B2 - very low and implying that it is extremely risky. It is 3 notches lower than India, and 2 notches away from default. A B2 rating suggests almost a 50% likelihood of default.

    EQM: What is your idea of a perfect, non-working day?

    Ms. Lindow: I am an avid skier. I have to say that my idea of the perfect day is to go out to the western US, and spend a day skiing under the bluest of skies and green trees, with moderate temperatures but with deep, deep snow…it's pure exhilaration and total relaxation at the same time.

    EQM: We will get Kashmir open for you

    Ms. Lindow: (laughs) Oh, the promise of that! Yes, yes, yes.

    EQM: Which 3 people have influenced you the most? Why?

    Ms. Lindow: I can look back at the teachers I had in elementary school, in high school, and at college. I think they fanned the interest I already had in political science and foreign affairs right from the time I was very young. They lifted that flame higher. They were mainly political science teachers, or in a related vein, my professor for ancient Greek philosophy when I was a freshman in college whose insight helped teach me how to analyse problems…so professionally, my teachers have been my most important influence. And then, on a personal level, I have a cousin who is like a sister to me who has gone through the most unbelievable adversity yet she remains incredibly positive and hopeful and never gives up. Her example inspires me every day of my life.



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