Above all, the fiscal deficit and the overall debt of the government remained under control. Additionally, Indian corporates had substantially deleveraged. All these factors led to reduction of risk for the Indian economy. This triggered an outlook upgrade by Moody’s from “Negative” to “Stable”. However, the sovereign rating has been maintained at Baa3.
Why did Moody’s upgrade the outlook from Negative to Stable
Why did Moody's upgrade India's rating outlook to stable from negative? This applies to the foreign currency and local currency long-term ratings. Here are some key reasons for the upgrade.
a) Over last 2 years, Indian economy had been caught in a vicious cycle. The weakness in the real economy was getting transmitted to the financial markets and the weakness in the financial markets was, in turn, getting transmitted to the real economy. Moody’s believes that the downside risks from this negative cycle were receding.
b) While Moody’s has pointed to the high fiscal deficit at 9.3% in FY21 and 6.8% in FY22 as a key risk, it has also underlined that the clear timetable was a major boost, assuming that India does stick to its commitment to gradually wind down the fiscal deficit as a percentage of GDP.
c) Moody’s noted that the recovery of the real economy was palpable and genuine. Economic activity was picking up across India and also broadening across a gamut of sectors. Real GDP is expected to surpass pre-COVID levels this year and a 6-7% real GDP growth is expected to sustain well into the future, with positive surprise potential.
d) On the management of the pandemic, Moody’s has pointed out that the fiscal and monetary measures had given a major boost while the aggressive vaccination drive had mitigated the short-term risks of a COVID resurgence. Even if the resurgence was to happen, the impact would be peripheral.
e) Moody’s has expressed confidence that India will be able to sustain nominal GDP growth at 10-11% over next few years. This will go a long way in mitigating fiscal stress and in containing government debt. In addition, the sharp turnaround in the current account from deficit to surplus had reduced India’s vulnerabilities to external shocks.
Then, why did Moody’s only hold the rating at Baa3?
According to Moody’s, while the time was ripe for an outlook upgrade, the Indian economy was still short of meeting the conditions for a rating upgrade above Baa3. However, the upgrade of the outlook to stable gives an additional buffer. Meanwhile, here are 3 reasons why Moody’s opted to just hold the ratings at Baa3.
- According to Moody’s, the level of borrowings remains a challenge. Government debt surged from 74% of GDP to 89% of GDP between 2019 and 2020, while interest payments are 26% of government revenues. Both these ratios are substantially higher than the Baa3 peer group.
- Low per capital income at under $2,000 in actual terms and around $6,400 in PPP terms is still among the lowest in the Baa3 peer group. That makes large sections of the Indian population highly vulnerable to economic shocks.
- Thirdly, fiscal deficit remains a challenge as it has shot up from 3.5% to 9.3% in FY21. The government needs to exhibit genuine intent and commitment to reduce the fiscal deficit in a time-bound manner. Moody’s also pointed to the high state fiscal deficit. In fact, the combined fiscal deficit for centre plus states stands at 13.5% of GDP.
These challenges stood between India and a rating upgrade. In addition, Moody’s has noted that India also scored very low on ESG parameters, and that called for urgent action.
Looking ahead, what could trigger a change in rating?
A change in rating could go both ways. India has been pushing for a rating upgrade from the current Baa3 levels. Moody’s has underlined some of the factors that could trigger an upgrade in sovereign rating. Baa3 is the lowest investment grade and just one notch above speculative grade. For India, the room for error is too small.
Moody’s is clear that India must sustain and accelerate its macroeconomic and financial market reforms. There is no compromise on opening up the Indian economy and taking up tough structural reforms. Indian economy will have to exhibit sustained higher growth. But the bigger trigger for an upgrade would be the ability to maintain fiscal discipline at a time when fiscal profligacy looks the easier option.
Of course, inflation, debt/GDP and the combined fiscal deficit at 13.5% remain key risk factors. As Moody’s puts it, the one thing that really gives comfort about India is that no default in bonds or loans has been recorded in India in the last 38 years! That is, certainly, a feel-good factor!