A (WTF) downgrade

Image: Eric Parker

It was a bad day at the office for Indian economy on the 9th November, even if it was not one for the Indian cricketers at the Delhi Feroz Shah Kotla Maidan, against the visiting West Indies. Automobile sales plunged in October. That is no bad thing actually given the imbalance between consumption (too much) and investment spending (too little) in India. Then, one does not have to feel bad about plunging car sales in India.

A Wikipedia entry notes that Pakistan has the highest number of vehicle in the world running on Compressed Natural Gas. Therefore, the plunging sale of autos in a country that is polluted by petrol and diesel vehicles (Is Delhi more or less polluted than Beijing?) is actually a good thing.

Then, Moody’s downgraded the outlook for Indian banking system from stable to negative.

That there are cyclical problems facing Indian banks is not in dispute. Government is pre-empting loan funds of the banking system and is not compensating the banks adequately. They are deprived of lending them to the private sector at higher rates of interest. Savings rates have been de-regulated. So, banks would compete and pay more for tapping people’s savings. Corporate profits are declining and hence bad debts provisioning will rise too. All this is known and India is paying the price for its transparency.

Its giant neighbour (China was never a neighbour to India throughout history and this is another topic for another occasion) to the North has an entirely State dominated banking system and an economy with even greater financial repression. It under-counts and under-reports its bad debts systematically. Those who dare to raise their voice are forced to withdraw their reports (See link).

Banks have large exposure to local governments who are dependent on land banks sales for their revenues. Banks have exposure to developers who want the prices of land banks to decline. Their apartment prices are dropping and transactions are plunging. A more recent Bloomberg/BusinessWeek news story points out that 473 billion dollar worth of loans outstanding from China Township governments has not been accounted for by the National Audit Office report published in June. So, we have no idea of the true health of Chinese banks or, for that matter, the whole economy. We will never have one.

Yet, on November 8th, Moody’s reaffirmed its ‘stable’ outlook for Chinese banks.

Readers should take note of a salient comment made by James Kynge in his piece in Financial Times (‘Cracks in Beijing’s financial edifice’) on October 9th. His key sentence is reproduced below:

“…. the pertinent question today is not whether China can once again guide the global economy away from the rocks but whether Beijing retains decisive control over its own economic levers….”

It is useful to remember and recall here that Italy’s troubles started after Moody’s decided to place Italy’s debt rating on review for possible downgrade. It was on June 17th. At that time, the 10-year Italian sovereign yield was 4.8%. It went to as high as 7.5% recently and only sustained buying of the bond by the European Central Bank has brought it back below 7.0%. In trying to anticipate contagion, Moody’s has precipitated a contagion.

Let us now remind ourselves the role played by American financial institutions in helping European sovereigns hide their debt. Accessories to a crime are equally guilty. Interestingly, in a news-story dated February 25, 2010 in the Financial Times, Mr. Bernanke (the chairman of the US Federal Reserve Board) is cited promising an investigation into the role of Goldman Sachs in helping camouflaging its debt. Whatever happened to that investigation?

Whereas they did not follow the S&P on the downgrade of the US debt and they have retained the ‘stable’ rating for China banks, after expressing grave doubts on Chinese local government bad debt estimates.

Standard & Poor, in contrast, upgraded India’s banking industry risk assessment from 6 to 5 on the same day Moody’s downgraded its outlook. It brought down India’s risk assessment from 6 to 5, placing it on par with China, Thailand, Turkey and Portugal.

Based on the last publicly available report (Outlook: Asia-Pacific Banks, January 31, 2011) issued by FitchRatings, India’s banking systemic risk rating is C1 compared to China’s D3. The lower the alphabet, the better the rating (i.e., the lower the risk) is.

As the world economy faces critical times, high-stakes games at the geo-political level are inevitable. Private sector entities would not be above being co-opted into these processes because their conduct then and now leaves enough scope for their governments to arm-twist them into co-operating with the governments’ mission. One cannot eliminate it but certainly more competition would help.

There is clearly a need for some credible rating agency from the developing world to emerge. Right now, there is only Dagong from China. More are required.