After The Upgrade: The Road ‘Up’ Ahead
Implementation of ongoing reforms is crucial to substantially upgrade India’s future growth trajectory.
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The Indian economy has witnessed two significant global endorsements in the last three weeks. Earlier, the World Bank upgraded India’s rank in its Doing Business 2018 report to 100 from 130 last year, thereby turning India into one of the fastest improvements. On Friday, international rating agency Moody’s upgraded India’s long-term sovereign rating to Baa2 from Baa3 (lowest investment grade rating) earlier, accompanied by a change in outlook on the rating to ‘stable’ from ‘positive’ earlier.
Rationale Behind The Upgrade
Moody’s highlighted the following key enablers that helped in improving India’s credit profile:
- Reforms to strengthen institutional framework and foster sustainable growth;
- Government’s support to public sector banks mitigates banking sector risks;
- Government debt likely to remain stable.
Setting up and successful adoption of institutional frameworks like the flexible inflation-targeting Monetary Policy Committee, Insolvency and Bankruptcy Code, and the Goods and Services Tax over the last two years have played a crucial role in increasing the likelihood of a structural increase in India’s potential growth. Meanwhile, efforts towards gradual liberalisation of the capital account, digitisation, and financialisation (via demonetisation and direct benefit transfer) will impart productivity boosts while also improving transparency. In the near term, the recapitalisation scheme announced by the government for state-owned banks is expected to address capital-related concerns for the banking sector and is also likely to improve appetite for credit offtake in the economy.
On the fiscal front, “efforts to improve transparency and accountability, including through the adoption of a new Fiscal Responsibility and Budget Management Act, are expected to enhance India’s fiscal policy framework and strengthen policy credibility”. While the debt level is relatively high for India (68 percent of GDP vis-à-vis Baa median of 44 percent), the impact is mitigated somewhat by
- 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 over time, with the weighted average maturity on the outstanding stock of debt now standing at 10.65 years,
- Over 90 percent of government debt is owed to domestic institutions and denominated in rupees, thereby lowering the impact of financial market volatility.
Moodys’ expects debt-to-GDP ratio to increase to 69 percent in FY18 on the back of moderation in nominal growth post implementation of GST.
The recently announced bank recapitalisation plan by the government could further add 0.8 percent to growth over the next two years.
However, the medium-term debt burden could remain broadly stable as the full impact of past economic reforms start impacting growth favorably and as the country moves towards a structurally higher phase of tax compliance and revenue buoyancy.
Implications
Friday’s rating move will provide immediate relief to the domestic bond market, which has seen a significant buildup of selling pressure over the last one-two months. The 10-year government-security yield is currently trading at 6.98 percent, about 8 basis points lower than its previous close.
Going ahead, if our baseline projections hold, then the 10-year yield could trade close to 6.95 percent by March 2018.
On the foreign exchange front, the sentiment boost from the rating upgrade helped the rupee to strengthen by around 0.8 percent on Friday at the time of writing. From a medium-term perspective, if other rating agencies like Fitch and S&P join Moody’s in upgrading their ratings on India, then this could imply further positive impetus to the currency over the next 1-2 quarters. While India’s foreign institutional investor debt limits are already exhausted to the extent of 98 percent (central government bonds) of the assigned limits, the renewed confidence with regard to the Indian economy (and likely rebalancing of emerging market funds to account for India upgrade) would open up avenues for FII investment into equities, which are tracking near-nil on an fiscal year-to-date basis (FII debt: $17 billion, FII equity: $1.2 billion).
However, even as domestic fundamentals support, global risks could continue to play spoilsport, in the form of monetary policy normalisation by global central banks and recent hardening in international energy prices.
Consequently, we maintain our projections of range-ish dollar-rupee (Dec 2017: 65.5, March 2018: 64.5, June 2018: 65.0, September 2018: 66.0), with a mild depreciation bias, as the currency is caught between global developments and (residual) near-term concerns with regard to domestic fiscal ratios.
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In terms of the impact of the ratings move on broader macros such as growth and investment, we maintain our views of gradual normalisation in economic activity in FY18 (Yes Bank estimate: 6.8 percent GDP, 6.6 percent GVA), backed by an uptick in consumption and exports. While positive multipliers would indeed be noted from a boost to the investment sentiment and greater FDI flows into India, amid Friday’s ratification of ongoing structural reforms by global rating agencies, these will take time to manifest into a pickup in real activity. In the interim, implementation of the ongoing reforms would be just as imperative, to substantially upgrade India’s future growth trajectory on a sustainable basis.
Shubhada Rao is group president and the chief economist at YES Bank.
The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.