Ratings and India – Story of Tailwinds and Headwinds

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Moody’s, S&P, Fitch…. These names ring a bell? Read them somewhere? Yes. I came to know about these names when I first came to know that every country gets a rating. Further, during my post-graduation, I learned more about them during internship. So, what are these companies/firms and why do they rate every country? Let’s understand it here.

What is a credit rating?

A credit rating is an opinion of the general creditworthiness of countries, companies and individuals. What they do is, assess how likely a borrower is to be able to repay its debts and help assess a fair price to charge. Lower credit ratings mean higher risk of default which leads to higher borrowing costs.

What are sovereign credit ratings?

Sovereign credit ratings measure the risk of investing in countries – These acts as a guide to gauge an economy’s monetary, fiscal and regulatory environment, as well as, the policy consistency. A favourable rating raises the economy’s attractiveness as a global business hotspot and investment destination. A sovereign is typically deemed to default when it fails to make timely payment of principal or interest on its publicly issued debt, or if it offers a distressed exchange for the original debt.

So what’s the big news on India’s rating?

Moody's Investors Service has upgraded the Government of India's local and foreign currency issuer ratings to Baa2 from Baa3; and changed the outlook on the rating to stable from positive. India’s rating has been upgraded after a period of 13 years. India’s sovereign credit rating was last upgraded in January 2004 to Baa3 (from Ba1). 13 years is a very long period considering India has been hailed as the next big thing in the global economy and we have been growing at an average of above 6% (minimum basis) since the past decade.

So what took so long? And why now?

Irrespective of the political party at the centre, the political leadership has been reluctant to make institutional changes. This government has stressed on implementation of polices at an accelerated pace and focused on the ability of reforms to translate into sustainable growth. Three key reforms mentioned by Moody's - Aadhaar, demonetisation and GST. One should also acknowledge the fact that majority of these policies were conceived by the earlier government. In short, we can say that the strong political will present has helped India here.

Moody’s also warned that India’s rating could be downgraded if its fiscal metrics and the outlook for general government fiscal consolidation deteriorate materially. “The rating could also face downward pressure if the health of the banking system deteriorated significantly or external vulnerability increased sharply”- it said.

As per the Moody’s rating note, government debt stood at 68 per cent of GDP in 2016. It expects the debt to GDP ratio will increase by one per cent on account of demonetisation and implementation of GST in the current fiscal year.The government has been facing sharp criticism after growth rate of 5.7 per cent in Q1 of 2017.

Moody’s also acknowledged the improvements in monetary policy framework and measures to address the piling up of non-performing assets (NPAs) in the banking system. It considers the roadmap to recapitalise public sector banks laden with poor quality assets to be a remedy for the economy.

The report says the government efforts to reduce corruption, formalise economic activity and improve tax collection and administration, should contribute to the further strengthening of India's institutions.

But why didn’t other rating agencies upgrade India?

After Moody’s rating, the government and markets were expecting the other rating agencies to follow suit. But that did not happen. S&P maintained its rating at BBB- and kept the outlook stable citing a sizeable fiscal deficit, high general government debt and low per capita income. S&P last upgraded India’s sovereign rating to BBB– from BB+ in January 2007. S&P said the stable rating outlook reflects its view that over the next two years, India’s growth will remain strong. Upward pressure on the ratings could build if the government's reforms to reduce and contain fiscal deficit work out. Downward pressure on the ratings could emerge if GDP growth disappoints. Moreover, it would like to see the results of the government reforms coming in before it goes in for a rating revision.

"The timing of the upgrade by Moody’s is odd, India's widening deficit is made worse by a pick-up in oil prices, while creeping inflation will limit the Reserve Bank of India's options in managing policy to boost growth.”Says Vishnu Varathan, Mizuho's head of economics and strategy.

India has been able to reduce the fiscal deficit can be attributed to subdued global oil prices and increased taxes on petrol and diesel. The excise duty on petrol and diesel has been raised 9 times since November 2014. India was one of the biggest beneficiaries of declining commodity prices, experiencing terms-of-trade windfall gains amounting to 3.4% of GDP in 2015-16, according to estimates by the International Monetary Fund (IMF).

The centre’s tax revenue from petrol and diesel rose from 0.44% of gross domestic product (GDP) in 2013-14 to 1.44% of GDP in 2016-17. Furthermore, the risk of waiving more loans by farmers to gain political favour for the upcoming elections adds to concerns about the government's finances and fiscal discipline.

To conclude, although India may benefit from the better management of the macro-economic factors, the microeconomic concerns have continued to increase. This means that there is still a lot of work to be done. The government should not lose sight of some of the real issues on the ground — The impact that demonetisation has had on small businessmen, the confusion around GST, the volatile oil prices that can upset the fiscal balance and the real, on- ground situation in the ease of doing business.