Subject: Economics

Central idea: India is seeking an upgrade to its sovereign credit rating, currently at the lowest-possible investment grade, as it believes its economic metrics have improved considerably since the pandemic.

What are Sovereign Credit Ratings?

• A sovereign credit rating is a measure of a country’s creditworthiness, or its ability to meet its financial obligations.
• It is an assessment of the credit risk associated with a country’s bonds or other debt securities.
• The rating is assigned by credit rating agencies such as Standard & Poor’s, Moody’s, and Fitch Ratings.

India’s current ratings

• S&P and Fitch rate India ‘BBB-‘ and Moody’s ‘Baa3’, all indicative of the lowest-possible investment grade, but with a stable outlook.

What does BBB mean?

• A ‘BBB’ rating indicates that expectations of default risk are currently low.
• The capacity for payment of financial commitments is considered adequate, but adverse business or economic conditions are more likely to impair this capacity.

What is a Rating Agency?

• Rating agencies assess the creditworthiness or potential of an equity, debt or country.
• Their reports are read by investors to make an informed decision on whether or not to invest in a particular country or companies in that geography.
• They assess if a country, equity or debt is financially stable and whether it at a low/high default risk.
• In simpler terms, these reports help investors gauge if they would get a return on their investment.

What do they do?

• The agencies periodically re-evaluate previously assigned ratings after new developments geopolitical events or a significant economic announcement by the concerned entity.
• Their reports are sold and published in financial and daily newspapers.

What grading pattern do they follow?

• The three prominent ratings agencies, viz., Standard & Poor’s, Moody’s and Fitch subscribe to largely similar grading patterns.
• Standard & Poor’s accord their highest grade, that is, AAA, to countries, equity or debt with the exceedingly high capacity to meet their financial commitments.
• Its grading slab includes letters A, B and C with an addition a single or double letter denoting a higher grade.
• Moody’s separates ratings into short and long-term definitions. Its longer-term grading ranges from Aaa to C, with Aaa being the highest.
• Fitch, too, rates from AAA to D, with D being the lowest. It follows the same succession scheme as Moody’s and Fitch.

Significance of such ratings

• Access to Capital: Higher credit ratings mean that a country can access capital at a lower cost, while lower ratings indicate that borrowing costs will be higher.
• Investment Decisions: Investors use credit ratings as a tool to evaluate a country’s creditworthiness and assess the level of risk associated with investing in that country.
• Economic Growth: Higher credit ratings typically lead to increased foreign investment, which can create jobs, boost productivity, and stimulate economic growth.
• International Trade: Countries with higher credit ratings are viewed as more stable and trustworthy, making them more attractive trading partners for other countries.
• Reputation: Countries with lower credit ratings may be seen as less reliable or stable, which can negatively impact diplomatic relationships and political influence.

Criticism of the rating agencies

• Credibility: Popular ratings agencies publicly reveal their methodology, which is based on macroeconomic data publicly made available by a country, to lend credibility to their inferences.
• Bias: These agencies were subjected to severe criticism for allegedly spurring the financial crisis in the United States, which began in 2017.
• Fouled metrics: The agencies underestimated the credit risk associated with structured credit products and failed to adjust their ratings quickly enough to deteriorating market conditions.
• Erroneous: They were charged for methodological errors and conflict of interest on multiple counts.

Why is India seeking upgrade in its credit ratings?

• Improved creditworthiness: These ratings are used to judge a country’s creditworthiness, often impacting its borrowing costs.
• Stable indicators: India has series of stable parameters such as economic growth rate, inflation, general government debt and short-term external debt as a percentage of GDP, and political stability, among others.

Measures taken to improve ratings

• India aims to cut its fiscal deficit to 5.9% of GDP next fiscal year, from the 6.4% target for the current year that ends March 31, and to further reduce that to 4.5% in the next three years.
• India’s Economic Survey has forecast growth of 6% to 6.8% for 2023-24, which would make it one of the world’s fastest-growing major economies.

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Central idea: The shutdown and takeover of Silicon Valley Bank (SVB) by US regulators has raised questions on how it impacts India’s startup industry. It was an important partner for the global startup economy.

What is SVB crisis?

• SVB Financial Group runs one of the largest American commercial banks – Silicon Valley Bank.
• Last week, it had announced a $1.75 billion share sale programme to further strengthen its balance sheet.
• This programme triggered a massive sell-off in the group’s shares.
• Thereafter, market went severely bearish and bear rampage wiped out over $80 billion of its market value.
• Alongside, the bond prices of the group collapsed and created a panic in the market.

Reasons for SVB’s downfall

• Downturn of tech stocks: The bank was hit hard by the downturn in technology stocks over the past year as well as the Federal Reserve’s aggressive plan to increase interest rates to combat inflation.
• Lower bond yield due to lower interest rates: SVB bought billions of dollars’ worth of bonds over the past couple of years, using customers’ deposits as a typical bank would normally operate.
• Mostly startups account holders: SVB’s customers were largely startups and other tech-centric companies that started becoming needier for cash over the past year.
• Drying VC funding: Venture capital funding was drying up, companies were not able to get additional rounds of funding for unprofitable businesses.
• Fear over deposit insurance: Since its customers were largely businesses and the wealthy, they likely were more fearful of a bank failure since their deposits were over $250,000, which is the government-imposed limit on deposit insurance.

Immediate effects of SVB’s failure

• Startups scramble: Many startups and other companies that relied on the bank’s services were suddenly left without access to their funds, which caused financial strain and uncertainty for these businesses.
• Ripple effect: They now fear that they might have to pause projects or lay off or furlough employees until they could access their funds.

Major implications for SVB

There are two large problems remaining with Silicon Valley Bank-

• Huge uninsured deposits: The vast majority of these were uninsured due to it’s largely startup and wealthy customer base.
• No scope for asset reconstruction: There is no potential buyer of Silicon Valley Bank.

Could this lead to a repeat of what happened in 2008?

• No probability: At the moment, experts do not expect any issues to spread to the broader banking sector.
• Diversified customer bases: Other banks are far more diversified across multiple industries, customer bases and geographies.

Impact on Indian startups

• Uncertainty over deposits: The failure of SVB is likely to have a ripple effect on Indian startups, many of which have significant amounts of funds deposited with the bank.
• Hamper the funding: SVB has been a major player in the Indian startup ecosystem, providing banking services and funding to many of the country’s most successful startups, including Flipkart, Ola, and Zomato.
• Ripple effect: This could lead to a cash crunch for many companies, which may be forced to cut costs, delay projects, or lay off employees.
• Reduce global footprints: SVB has also been instrumental in helping Indian startups expand into the US market, by providing them with the necessary infrastructure and support to set up operations in Silicon Valley.

How can Indian startups mitigate the impact of SVB’s failure?

• Diversify banking relations: Indian startups that have funds deposited with SVB may want to consider diversifying their banking relationships to reduce their exposure to any one bank.
• Alternative financing: This may involve opening accounts with multiple banks, or exploring alternative banking services such as digital banks or fintech startups.

Back2Basics: 2008 Financial Crisis

• The bankruptcy of Lehman Brothers was a key event in the 2008 financial crisis.
• Lehman Brothers was one of the largest investment banks in the world, with assets of around $600 billion.
• However, the firm had invested heavily in the US housing market, and when the housing market began to decline in 2007, Lehman’s investments began to lose value.
• In addition, the firm had taken on a large amount of debt to finance its investments and operations.
• As the value of Lehman’s assets declined and its debt levels increased, the firm became insolvent and was unable to meet its obligations to creditors.
• In September 2008, Lehman Brothers filed for bankruptcy, triggering a financial panic and market turmoil.

Its impact

• The Lehman crisis had far-reaching consequences, including the collapse of other financial institutions, a global recession, and widespread economic and social hardship.
• The crisis highlighted the risks of excessive leverage and the interconnectedness of financial institutions, and led to significant reforms in financial regulation and risk management practices.

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