US-based Moody’s has upgraded India’s sovereign credit rating by a notch to ‘Baa2’ with a stable outlook citing improved growth prospects driven by economic and institutional reforms. Moody’s has also upgraded India’s local currency senior unsecured rating to Baa2 from Baa3 and its short-term local currency rating to P-2 from P-3.
Notably, the rating upgrade, the first since 2004, comes close on the heels of 30 notches jump in India’s ranking in the World Bank’s Ease of Doing Business Index to the 100th spot.
In our Union Budget 2017-18 review document we had highlighted to our clients that in view of transformational reform measures announced by the Government sovereign rating upgrade is now imminent. Even the Moody’s report suggests that the decision to upgrade rating has come after a year of review of the reforms initiated by the Modi Government and it is underpinned on the expectation of continued progress on economic and institutional reforms to translate in high and sustainable growth for India going forward.
The upgrade comes as a major boost to the Narendra Modi government, which has been drawing flak for the fallout of GST and impact of demonetization on GDP. In fact, as per Moody’s, Government efforts to reduce corruption, formalize economic activity and improve tax collection and administration should contribute to the further strengthening of India’s growth prospects and improve it fiscal position which will also have a positive impact on long term investments. We are of the view that this impact will boost the confidence among the foreign and domestic investors which would lead to increased participation in bond and stock market investments, thus leading to stronger INR.
As per the Moody’s release, rationale for ratings upgrade include factors like: –
- Reforms to foster sustainable growth – Moody’s report mentions that while there are a number of reform measures that remain in the drawing phase but of those that have already been implemented till date will advance India’s growth prospects by improving overall business climate and enhancing productivity in the economy. This move will stimulate increased inflows of foreign capital in a host of Indian financial asset classes such as stock market investments and real estate. The key reform programs implemented till date that lend assurance for sustained growth in coming years include the recently-introduced Goods and Services Tax (GST), strengthening of the Insolvency and Bankruptcy Code (IBC) measures to address the overhang of non-performing loans (NPLs) in the banking system, implementation of the Aadhaar system of biometric accounts and targeted delivery of benefits through the Direct Benefit Transfer (DBT).
- Reforms paving way for gradual reduction in Government debt– Moody’s in its report has noted that these reforms are enabling a) higher degree of formalization in the economy, b) broadening of the tax base (under GST), c) promotion of expenditure efficiency by rationalization of Government schemes and d) targeted delivery of benefits (under DBT). Eventually these measures should translate in gradual reduction in public indebtedness of India, which is the principal contributing factor towards credit weakness of the country. However, Moody’s is the opinion that the debt burden will broadly remain stable over the next few years, before falling gradually as nominal GDP growth continues and revenue broadening and expenditure efficiency enhancing measures take effect.
- Reforms to strengthen India’s institutional framework – On the fiscal front, efforts to improve transparency and accountability through adoption of a new Fiscal Responsibility and Budget Management (FRBM) Act, are expected to improve India’s fiscal policy framework and strengthen policy credibility. The other reforms that have helped in the upgrade are adoption of flexible inflation targeting regime and a formation of Monitory Policy Committee for setting up of interest rates.
- Governments’ support to Public Sector Banks (PSB) mitigating banking sector risk that in turn will propel growth – A comprehensive recapitalization initiative for the PSBs and proactive steps taken to resolve the NPL problem plaguing the banking system will be key enablers for de-clogging of the credit pipeline in the country and thereby spurring growth over the medium term.
The rating agency has maintained that most of these measures will take time for their impact to be seen on growth and long term investments, and some, such as the GST and impact of demonetization on GDP, have undermined India’s growth over the near term. Overall Moody’s expects real GDP growth to moderate to 6.7% in the fiscal year ending in March 2018. However, as disruption fades, real GDP growth is expected to rise to 7.5% in FY2019, with similarly robust levels of growth there onward. The report even goes on to state that in the longer term, India’s growth potential is significantly higher than most other Baa-rated sovereigns.