Are rating agencies reliable for investment decisions?

India has five rating agencies currently. CARE, Crisil, and Fitch are three main contenders in this business. As I understand, before getting loan or debt , one has be get validated by one rating agency. These are third parties and independent parties to give view on investment. They get some percentage from company to get it reviewed at initial stage and years afterwards. Investor makes decisions based on their ratings. It is very hard for investor to go and review all investment options. BBB is supposed to be investment grade decision. There are internal and external reviews of rating after getting final numbers. There are some risks on relying on their decisions

1. Conflict of interest: They get paid by the company who is looking for loans. Both parties look for business.

2. Sudden change of business perception: Recession and good times have two different perceptions about a business. People go by brand name and rely more on owner than business ideas. In recession time, overall risk appetite changes so “A” grade company may get BBB. Mean of risk keeps changing. Satyam got best rating and just after few months they were on verge of default. Similar is case of 3i InfoTech. Crisil confirmed rating as “A” last month and this month they changed it to junk.

3. Highly risky products/Projects: It is very difficult to judge a company on project stage. No one where company can falter. Company can be good in one execution and may be bad in another. Even the finest director can’t guarantee success of a film. It is mix of product, marketing, demand, external environment and execution. A simple default may lead to fall in idea. Even Google is finding hard to face Facebook in social media despite having in-house technical skill and large user base. People were apprehensive in investing in Reliance in earlier days. Now they may find investor easily.

4. Complex products: Companies are so linked together. Stakes are so unclear in today’s market that most of the things lead to insurance. Derivatives have created very risky world. Generally, a big daddy supports small projects and his credibility is used to back small innovation.

5. Sovereign Issues: Credibility of rating agencies have been affected by EU and USA’s debt crisis. Despite having slow and steady growth rates during last 8-9 years, these countries are enjoying AAA or AA rating. India (BBB) and China are giving 9-10% growth year on year and their GDP is also getting stronger. Still rating is poor comparatively. Some perception matching should happen to get credibility back in rating agencies.