Saturday, May 29, 2010

Systemic bias against emerging markets?

Some years ago, at a lunch discussion in Paris, an Israeli-American asked me what were the chances of a military takeover in India.

"Zero", I answered. I was met with incredulity and, I think, sniggers.

"You can't be so sure! How can you be sure?"

I tried to put it another way. I said something like this: "It is less than the chance of a military takeover in France, or Israel, or the United States -- simply because the army has almost no power in India, is entirely under the control of the political establishment, and it has no influence on Indian politics. Unlike in many developed countries."

More incredulity and audible chuckles, and the subject changed.

I got reminded of that exchange today in reading T N Ninan's takedown of the credit ratings issued by Standard and Poor (S&P) to several countries. (Go and read it now, before reading on.)

Ninan points out that while India has a BBB- credit rating, Spain, Portugal and Italy had an A+ or better rating just two months ago, and so did Greece a year ago. Yet none of the economic indicators -- budget deficit, unemployment rate, public debt, GDP growth rate -- suggest that India should be more risky than these countries. "As recently as in March, S&P was 'affirming' Greece's BBB+ status (which, please note, was better than India's)." China's rating, while better than India's, was also till recently lower than these European countries'.

How can the world's premier rating agency get it so wrong? "The rating agencies argue that emerging markets have a higher political risk. Well, tell that to the Greeks, who are rioting in the streets of Athens!"

Ninan suspects "systemic bias against emerging markets" but I think there is another explanation: Euro-zone countries, like AIG, Citigroup and other Wall Street giants, are "too big to fail". If they screw up their economics, they will be bailed out (it's already happening) because the alternative is the disintegration of the euro as a currency, which, apart from the purely economic consequences, would be a blow to European pride too awful to contemplate.

In India we have no such illusions: we are bigger than all the PIGS put together, but not too big to fail. (This may not apply to China, but it is difficult to see who'd have deep enough pockets to bail out China, were it to become necessary). But in a way that is good news for us: there is nobody to bail us out, so we have an incentive to keep our systems functioning.


Sachin Shanbhag said...

I don't know if it is a systemic bias, but my opinion of ratings agencies is comparable to my opinion of astrology. Entertaining, but of little real value.

For example, Moodys rated a lot of subprime CDS as AAA.

So I think stupidity+hubris rather than systematic bias is at play here.

Rahul Siddharthan said...

Sachin: true, but astrology has no rich-country bias.