Ratings agency Moody’s Investors Services said its recent upgrade of India’s sovereign rating, the first since 2004, was driven by its view that the Modi government’s structural reforms will enhance growth, improve competitiveness and gradually bring down the debt burden.
"The recent reforms offer greater confidence that the high level of public indebtedness, one of India's principal credit weaknesses, will remain stable, even in the event of shocks, and will ultimately decline," said William Foster, Vice President and Senior Credit Officer at Moody's, in a media statement.
The upgrade came at a time when rising oil prices and doubts about a fiscal slippage have added to the Centre’s challenges as it tries to prop up slowing economic growth. The ratings agency published an in-depth FAQ on the credit impact of the sovereign upgrade while explaining its decision.
Here’s what Moody’s said.
India’s debt-to-GDP ratio remains high. How does this factor into the upgrade?
India’s high public debt burden will likely remain an important constraint on its credit profile relative to peers, notwithstanding the mitigating factors that support fiscal sustainability. That constraint is not expected to diminish rapidly, with low income levels continuing to point to significant development spending needs over the coming years. Measures to encourage greater formalization of the economy, reduce expenditure and increase revenues will likely take time to diminish the debt stock.
However, we believe that recent reforms offer greater confidence that the high level of public indebtedness, which is India’s principal credit weakness, will remain broadly stable, even in the event of shocks, and will ultimately decline.
India's general government debt burden, at about 68 percent of GDP in 2016, is significantly higher than the Baa median of around 45 percent. Meanwhile, interest payments are about 22 percent of general government revenue for India, the highest interest burden among Baa-rated peers and nearly three times the Baa median of about 8 percent.
The impact of the high debt load is mitigated somewhat by the large pool of private savings available to finance government debt. Robust domestic demand has enabled the government to lengthen the maturity of its debt stock, more than 90 percent of which is owed to domestic institutions and denominated in rupees. The weighted average maturity on the outstanding stock of debt stood at 10.65 years as of fiscal year 2016 ended in March 2017, compared with 9.60 years five years earlier. This in turn lowers the impact of interest rate volatility on debt servicing costs and reduces refinancing risks since gross financing requirements in any given year are moderate.
In addition, measures that increase the degree of formality in the economy, broaden the tax base (as with the GST) and promote expenditure efficiency through rationalization of government schemes and better-targeted delivery (as with the DBT system), will support the expected, though very gradual, improvement in India’s fiscal metrics over time.
We expect India’s debt-to-GDP ratio to rise by about 1 percentage point this fiscal year, to 69 percent, as nominal GDP growth has slowed following demonetization and the implementation of GST. The debt burden will likely remain broadly stable in the next few years, before falling gradually as nominal GDP growth continues and measures that broaden revenue and enhance expenditure efficiency take effect.
State deficits have been widening. What are the implications for India’s fiscal outlook and rating?
Deficit reduction at the central government level has been supportive of India's credit profile. However, a recent widening of Indian state deficits has more than offset the narrowing of the central government deficit.
Clearer focus on the general government debt level (combined central and state debt) as per the Fiscal Responsibility and Budget Management (FRBM) Review Committee's1 recommendations would help to address concerns about the management of state deficits, which have deteriorated recently and risk undermining fiscal consolidation at the center.
State government deficits have risen steadily to about 3 percent of GDP from around 2 percent in fiscal 2012.
In the last two years, many states issued Ujwal DISCOM Assurance Yojana (UDAY) bonds as part of a government program to restructure the outstanding debt of state electricity boards (DISCOMs). According to the Reserve Bank of India (RBI), this added about 0.7 percentage point of GDP to states' gross fiscal deficits, raising them to 3.6 percent of GDP from what would have been 2.9 percent in the fiscal year ended March 2016.
Wider deficits have led to an increase in state bond issuance (state development loans, or SDLs) and interest payments. Meanwhile, salary increases for state employees could add to pressure on expenditures.
Finally, recent announcements of farm loan waivers by some Indian state governments, if not offset by expenditure reductions, risk further widening state deficits. Such loan waivers also risk setting expectations of future loan forbearance, which could relax borrowers’ attitudes toward repayment and further undermine asset quality in the banking system, another constraint on India's credit profile.
However, the states are limited in how much they can spend, because the central government caps their ability to borrow beyond budget deficits of 3 percent of GDP. This rule should serve to constrain future state expenditure and limit the extent of state fiscal slippage.
A durable and effective reduction in state deficits will be a critical component of reducing India's high general government debt burden.
Also Read: Moody’s India Upgrade Long Overdue: Government, Brokerages, Business Leaders And Investors React
How does the recently announced bank recapitalisation plan impact the government’s fiscal position and how has it been factored into the Baa2 rating?
On 24 October, the government announced a Rs 2.1 lakh crore (around $32 billion) recapitalisation plan for Indian Public Sector Banks (PSBs). The size of the recapitalisation is large enough to allow PSBs to meet regulatory capital requirements and absorb greater provisioning of bad loans.
The recapitalisation is credit positive for the sovereign. While the capital injection will modestly increase the government’s debt burden (by about 0.8 percent of GDP), it should enable banks to move forward with the resolution of NPLs through comprehensive writedowns of impaired loans and gradually increase lending. Over the medium term, if met by rising demand for investment and loans, this will help foster more robust growth and support fiscal consolidation.
Beside the recapitalisation, since the Insolvency and Bankruptcy Code 2016 was introduced in May 2016, there has been a strong regulatory push toward the resolution of large corporate NPLs. The Reserve Bank of India is instructing banks to increase provisioning, which in turn will enable them to take charges required for the disposal of problem assets in the market. While banks will have to absorb higher credit costs, the regulatory actions are credit positive as they may lead to more active NPL resolutions.
Also Read: Moody’s Takes A Leap Of Faith On India
What is the reason for an upgrade amidst the current macroeconomic slowdown?
While we have lowered our forecast for Indian GDP growth to take into account the recent slowdown, the economy’s growth potential is strong and stronger than most peers. Combined with a large and diversified economy and improving global competitiveness, this boosts economic strength, our view of an economy’s shock absorption capacity, which we assess as “High (+)”, the fourth highest score on our 15-rung sovereign factor score scale.
India's real GDP growth slowed to 5.7 percent year-over-year in the second quarter of calendar year 2017, following a slowdown to 6.1 percent in the first quarter from 7.0 percent in the fourth quarter of 2016. The economic slowdown reflects the temporary impact of demonetization and destocking of inventory in advance of the implementation of the GST in July.
Meanwhile, a material rise in imports over the past two quarters suggests that domestic supply chains have been disrupted, particularly among small and medium-sized enterprises (SMEs), as they begin to integrate into the formal economy and increase tax compliance as a result of demonetization and GST.
We expect the disruption of domestic supply chains to restrain growth over the next few quarters as SMEs and exporters continue to adjust to the new GST regime. As a result, we expect real GDP growth to moderate to 6.7 percent in fiscal year 2017, which ends in March 2018.
However, as disruption fades, assisted by recent government measures to support SMEs and exporters with GST compliance, we expect to see a rebound in real GDP growth to 7.5 percent in fiscal year 2018 ending in March 2019, with similarly robust levels of growth from fiscal 2019 onward. Longer term, India’s strong growth potential and improving global competitiveness will be core credit strengths.
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