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  • NOVEMBER 25, 2009

With an A+ why worry about TBTF?

Credit rating agencies these days seem to be looking at a lot beyond loan servicing capabilities. No, we are not just referring to rating of companies but also that of economies. What else can explain the anomaly that as of November 2009, the Government of India has a higher probability of defaulting than the defunct entities did before their collapse? Indian government's current rating is poorer than Enron's and Lehman's few days before collapse. Currently, the Indian government's BBB- sovereign rating is the same as that of Iceland. At the same time, the UK which has a handful of banks going bankrupt every day is rated AAA while China is placed at A+.

We were particularly intrigued by an article in a business daily by the Indian Ambassador to the European Union. It suggests that this partial rating will cost India US$ 25 bn. The rationale is thus. At the end of March 2009, India's external debt was about 40% of her total borrowings. They attract an additional cost of 2% due to India's relatively low credit rating. We assume that the country will access half the US$ 500 bn needed for infrastructure projects of debt funding from external sources. At an additional 2%, the interest cost will be higher by US$ 25 bn over 5 years. This is a punishment meted out to India Inc. for not being Too Big To Fail (TBTF). Indian banks that collectively have capital adequacy of over 13% must also bear the brunt.

Speaking of China that has an A+ rating, it has little to worry! Even if its banks run out of capital having lent an enormous amount in no time. The country's 5 biggest banks lent a record 4.7 trillion yuan (US$ 688 bn) in the first nine months of 2009. Of course, this helped China prop up its economic growth to 8.9%. According to BNP Paribas, Chinese lenders would need as much as a US$ 368 bn yuan to keep their capital adequacy ratios at 12%.

The OECD believes that China may need to rein in credit growth to tame inflationary pressures. Suspicions of a big bubble building up in China seem to be getting stronger with each passing day. The country's stock market has soared ahead of its Asian peers. Home prices in 70 major Chinese cities climbed at the fastest pace in 14 months in October 2009. But the A+ ensures that Chinese banks and companies have little to worry. Just as those in the US and UK do.

We would like to leave you with one quote that does its bit to explain Buffet's opinion on rating agencies. Moody's former managing director, Jerome Fons says that Mr. Buffett has long found his connection to Moody's a little awkward. Mr. Buffett never attended any board meetings, he says. Berkshire has never bought any additional shares after it acquired its stake in 2000. The shares were bought as part of a deal with Dun & Bradstreet, then its parent company. Mr. Fons further adds, "I think he'd love to sell his stake in the company, but he can't. As soon as it was known that he was selling, the value of the company would plunge."

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