Criteria for notching up standalone ratings of entities based on government support
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1 Criteria for notching up standalone ratings of entities based on government support Executive summary CRISIL may notch up the standalone ratings of government-related entities (GREs) based on the probability and extent of distress support that the government could provide to them. CRISIL classifies GREs into four categories based on the policy role they execute, and the economic and political implications of their on the government. Based on the classification, CRISIL decides if, and the extent to which, notch-up is to be provided to the GRE s rating. A. Scope of criteria CRISIL applies its notch-up criteria to the ratings of public sector undertakings (PSUs) that are majority owned by the Government of India (GoI). The framework may also be applied to entities that are not directly held by the government, but are majority owned by PSUs. GREs, therefore, include the whole gamut of entities that are likely to receive distress support from GoI. CRISIL exercises extreme caution while notching up PSUs held by state governments considering the governments unfavourable track record at extending timely support. This criteria may, therefore, not be applied to state government enterprises. B. Parameters for assessing likelihood of GoI support CRISIL may notch up a GRE s standalone rating based on assessment of the policy role played by the entity, the government s moral obligation to support the entity, and the implications of (see Chart1). Chart 1: Parameters for assessing extent of notch-up I. Policy role II. Implications of /Moral obligations Criticality of sector Strategic importance Domino effect Political/social implications of Public perception of sovereign backing GoI's stated posture 1
2 I. Policy role CRISIL assesses the GRE s role as an instrument of public policy, and the government s intention to retain the policy role with itself or with the public sector over the long term. The criticality of the sector in which the GRE operates, and the entity s strategic importance within that sector are factors CRISIL takes into account: i. Criticality of sector: Sectors are classified as strategic or non-strategic to GoI based on the government s disinvestment policy, allocation of funds to different sectors, and discussions with GoI officials. Sectors like regulation, defence production or rural infrastructure that GoI views as its obligations are considered highly strategic. Other sectors considered strategic to GoI include railways, roads, oil exploration, and power. ii. Strategic importance: The extent of private participation in a sector is treated as a proxy for the strategic importance of a GRE within the sector. GREs performing critical government functions and operating in sectors in which the private sector s role is expected to be limited are considered strategically important to the government. GREs that fulfil functions (such as regulation, defence equipment and rural infrastructure) that GoI views as its obligations, and in which private sector participation is likely to be limited, score high on policy role. Similarly, special purpose vehicles (SPVs) set up by GoI to raise resources for projects such as railways, transportation, power transmission, and road development, also score high on policy role. PSUs in manufacturing industries, however, where the private sector plays a large role, score low on this parameter. II. Implications of / Moral obligations The following parameters help gauge the economic, political, and social implications of by a GRE in debt servicing: i. Domino effect: This parameter captures the economic implications of. CRISIL determines whether the would have a localised impact or spill over to other entities in the sector. In the financial sector (particularly banks), for instance, by one entity could lead to loss of confidence, even liquidity constraints, in other entities in the sector. ii. Political/social implications of : The GRE s employee strength, the extent of unionisation, and the amount of outstanding retail and foreign currency debt are assessed to determine whether GoI could face political pressure in preventing a. There would be considerable pressure on GoI to also support GREs that fulfil a social role. Large banks score high on this parameter. The following parameters reflect moral obligations on the government to support a GRE in distress: i. Public perception of sovereign backing: GoI often needs to intervene and support entities in case there is significant public perception of such support. For instance, GoI has set up SPVs to channel funds to key sectors. The cash flows of many such SPVs are inadequate to meet debt repayment obligations. For such entities, resource availability from capital markets is based on a strong assumption of government support. Similarly, CRISIL believes there is significant public expectation of support for public sector banks. 2
3 ii. GoI s stated posture: Letters of comfort or guarantees from the government for a GRE s borrowing programme or capitalisation support reflect GoI s level of commitment towards the GRE. Also, if a GRE is allowed by the government to issue tax-free bonds, there would be significant moral obligations on the government to extend support to the GRE if it falls into distress. C. Extent of notch-up Based on the assessment of these parameters, CRISIL classifies GREs into four categories (see Chart 2): Chart 2: Classification of GREs Implications of High Limited policy role with adverse impact of (Notch-up depending on likelihood of support & standalone credit profile) Policy based institutions with adverse impact of (Equated to GoI rating, i.e., AAA) Policy role Low Policy role High Limited policy role with no repercussions of (No notch-up) Policy based institutions with no repercussions of (Notch-up of maximum 2 notches) Implications of Low I. Limited policy role with no repercussions of This category comprises GREs that are essentially commercial entities that play a limited policy role and whose could have low political or economic implications. Most such entities may continue to operate, despite. Most manufacturing GREs, excluding the defence sector, and PSUs approved for disinvestment, for instance, have low likelihood of support from GoI. Therefore, CRISIL does not notch up the ratings of such entities, and their ratings reflect their standalone creditworthiness. 3
4 II. Policy-based institutions with no repercussions of This category includes GREs engaged in coal production, power generation, and defence equipment manufacturing, which have received significant GoI support through equity infusion and loans in the past. These commercial and quasi-commercial entities could carry on their operations unimpaired, despite. CRISIL believes GoI may support such entities to ensure they remain solvent, but not necessarily to ensure timely debt servicing. Hence, the ratings of such entities are notched up by a maximum of 2 notches over their standalone ratings. III. Limited policy role with adverse impact of Typically, banks and some financial institutions belong to this category where the entity plays a limited policy role, but its could have extremely adverse political and economic implications. CRISIL, therefore, believes GoI will intervene in time to avert of the GRE. The extent of notch-up over the standalone rating may be much higher for such entities, and driven by the adverse impact of and the difference between the standalone rating and GoI s rating. IV. Policy based institutions with adverse impact of GREs such as regulatory agencies and SPVs established to channel resources (from capital markets) to key social or strategic sectors, and formed under special statutes, belong to this category. These entities carry out activities that are unlikely to be passed on to the private sector in the foreseeable future. Lack of government support to such entities may lead to funding and liquidity constraints, which, in turn, could impair resource allocation to target sectors envisaged by the government. CRISIL, therefore, equates the ratings of such entities to GoI s rating, CRISIL AAA. D. Conclusion CRISIL s government notch-up criteria factor in the likelihood of GoI extending support to the GRE in time of distress, depending on the policy role played by the GRE and implications of the entity s on the government. CRISIL classifies GREs into four distinct categories based on its assessment of the probability and extent of government support. The extent of notch-up to the standalone rating is determined by the category to which the GRE belongs. 4
5 About CRISIL Limited CRISIL is a global analytical company providing ratings, research, and risk and policy advisory services. We are India's leading ratings agency. We are also the foremost provider of high-end research to the world's largest banks and leading corporations. About CRISIL Ratings CRISIL Ratings is India's leading rating agency. We pioneered the concept of credit rating in India in With a tradition of independence, analytical rigour and innovation, we have a leadership position. We have rated over 95,000 entities, by far the largest number in India. We are a full-service rating agency. We rate the entire range of debt instruments: bank loans, certificates of deposit, commercial paper, non-convertible debentures, bank hybrid capital instruments, asset-backed securities, mortgage-backed securities, perpetual bonds, and partial guarantees. CRISIL sets the standards in every aspect of the credit rating business. We have instituted several innovations in India including rating municipal bonds, partially guaranteed instruments and microfinance institutions. We pioneered a globally unique and affordable rating service for Small and Medium Enterprises (SMEs).This has significantly expanded the market for ratings and is improving SMEs' access to affordable finance. We have an active outreach programme with issuers, investors and regulators to maintain a high level of transparency regarding our rating criteria and to disseminate our analytical insights and knowledge. CRISIL Privacy Notice CRISIL respects your privacy. We use your contact information, such as your name, address, and id, to fulfil your request and service your account and to provide you with additional information from CRISIL and other parts of McGraw Hill Financial you may find of interest. For further information, or to let us know your preferences with respect to receiving marketing materials, please visit You can view McGraw Hill Financial s Customer Privacy Policy at Last updated: November, 2015 CRISIL Limited CRISIL House, Central Avenue, Hiranandani Business Park, Powai, Mumbai India Phone: Fax:
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