Moody's Investors Service ("Moody's") last week 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.
Whilst developed countries like Australia face the potential of a ratings downgrade, Moody’s decision to upgrade the ratings is based on expectations that progress on economic and institutional reforms will enhance the potential of India’s already robust growth. Additionally, Moody’s expects that there will be a resulting gradual decline in general government debt over the medium term along with a reduced risk of a sharp increase in debt even in downside scenarios.
Rationale for Upgrade
- Reforms to Foster Growth
Reforms which are current and expected are likely to improve the business climate, enhance productivity and stimulate foreign and domestic investment. This will create a platform for strong and sustainable growth – making it a structural change rather than a tactical one. India’s increasing global competitiveness and improving ease of business also highlight the potential for greater growth and investment.
Key reforms like GST (introduced 1/7/2017) are already seeing positive impacts by creating a national transparent tax system and reducing barriers to interstate trade. The Government and Central Bank have also worked hard to improve the decision-making framework for monetary policy which is increasing economic stability. Just two weeks ago, the Government took action by recapitalising parts of the troubled banking system, which is required to facilitate greater capex/private investment.
Other key reforms like demonetization and targeted delivery of benefits through a national biometric identification card (Aadhaar Card) is intended to increase digital transactions and reduce the impact of the cash or informal economy. There are also significant reforms related to labour and land still to come which are likely to transform India over the next decade.
While we have seen India’s growth falter due to the short-term impact of reforms (5.7% 2QCY17), it is likely that the medium-term impact is a resumption of 7-8% growth. Longer term, India's growth potential is significantly higher than most other Baa-rated sovereigns.
2. Provide Greater Assurance that Government Debt is Likely to Remain Stable
Moody’s believe that recent reforms provide confidence that India’s public debt can be addressed and will eventually decline. Government debt at 68% is higher than the Baa rated median of 44%. The higher debt is somewhat mitigated by a high level of private savings and a weighted average maturity of debt of over 10 years.
The GST also broadens the tax base and improves the efficiency in the delivery of Government schemes. This should continue to improve India’s fiscal metrics.
3. Reforms Strengthening India’s Institutional Framework
Government reform efforts to reduce corruption, formalise economic activity and improve tax collection and administration is likely to continue to strengthen India’s institutions. Additionally, the focus has been on improving transparency and accountability which will enhance India's fiscal and monetary policy frameworks. Some signs of this are already evident through the construct of the Central Bank’s (RBI) Monetary Policy Committee.
However, significant progress is still required. There remain challenges with implementation of the GST, weak private sector investment and resolution required on non-performing loans. Additionally, reform progress is still required on land and labour. Nevertheless, Moody’s can see that progress is occurring in this area.
4. Government Support to Public Sector Banks Mitigates Banking Sector Risk, Supports Growth
Recent announcements of a recapitalisation of Public Sector Banks (PSBs) and positive changes in the Bankruptcy and Insolvency Act (2016) are improving India’s credit profile. Sure, the capital injection will increase the Government’s debt burden by 0.8% of GDP over two years, but it will allow banks to move forward with the resolution through write-downs and prosper from better lending practices learnt from legacy of the last decade. This in turn is also likely to help foster growth which should support fiscal metrics over time.
What Could Move the Rating
- Change in the fiscal metrics
- Investment cycle and its duration
- Continuation of supportive reforms
- Improving tax collection
Impact for Markets
We see this as being positive for India’s equity markets and currency in the short-medium term. It is one step along the way of improving fiscal metrics for India due to positive reform and harnessing of strong growth from India’s demographics.
Mugunthan Siva is Managing Director of India Avenue, an Australian based boutique asset management company with offices in Sydney and Mumbai. He has over 20 years experience in Australia and is lead portfolio manager for the India Avenue Equity Fund.