Insights into Editorial: Timely recognition: on the Moody’s upgrade

Print Friendly, PDF & Email

 


Insights into Editorial: Timely recognition: on the Moody’s upgrade


 Timely recognition: on the Moody's upgrade

Context:

US-based International rating agency Moody’s Investors Service has upgraded India’s sovereign credit rating by a notch to ‘Baa2’ with a stable outlook citing improved growth prospects driven by economic and institutional reforms. Moody’s has revised the sovereign rating of India after a long gap of 14 years.

The decision to upgrade the ratings is underpinned by Moody’s expectation that continued progress on economic and institutional reforms will enhance India’s high growth potential. It will also improve large and stable financing base for government debt, and will likely contribute to a gradual decline in the general government debt burden over the medium term.

The global ratings agency, however, cautioned that high debt burden remains a constraint on the country’s credit profile.

What is a credit rating?

A credit rating is an assessment of the creditworthiness of a borrower. Individuals, corporations and governments are assigned credit ratings — whoever wants to borrow money. Individuals are given ‘credit scores’, while corporations and governments receive ‘credit ratings’.

What factors decide these ratings and what could move the Rating Up?

There are several criteria behind rating a government’s creditworthiness. Among them are political risk, taxation, and currency value and labour laws.

  • Another is sovereign risk where a country’s central bank can change its foreign exchange regulations. These risks are taken into account and ratings assigned accordingly.

The rating could move up if there were to be a material strengthening in fiscal metrics, combined with a strong and durable recovery of the investment cycle, probably supported by significant economic and institutional reforms

  • Sustained reduction in the general government debt burden, through increased government revenues combined with a reduction in expenditures, would put positive pressure on the rating.

Rationale for upgrading the Rating to Baa2

The government is mid-way through a wide-ranging program of economic and institutional reforms.

  • While a number of important reforms remain at the design phase, Moody’s believes that those implemented to date will advance the government’s objective of improving the business climate, enhancing productivity, stimulating foreign and domestic investment, and ultimately fostering strong and sustainable growth.
  • The reform program will thus complement the existing shock-absorbance capacity provided by India’s strong growth potential and improving global competitiveness.
  • Key elements of the reform program include
  • The recently-introduced Goods and Services Tax (GST) which will promote productivity by removing barriers to interstate trade;
  • improvements to the monetary policy framework by efforts to improve transparency and accountability, including through adoption of a new Fiscal Responsibility and Budget Management (FRBM) Act;
  • measures to address the overhang of non-performing Assets (NPAs) in the banking system through an Insolvency and Bankruptcy Code;
  • demonetization;
  • The Aadhaar system of biometric accounts and targeted delivery of benefits through the Direct Benefit Transfer (DBT) system intended to reduce informality in the economy.
  • Other important measures which have yet to reach fruition include planned land and labour market reforms, which rely to a great extent on cooperation with and between the States.

India’s Growth forecast by Moody’s

Most of these measures by government will take time for their impact to be seen, and some, such as the GST and demonetization, have undermined growth over the near term.

  • Moody’s expects real GDP growth to moderate to 7% in the fiscal year ending in March 2018 (FY2017).
  • However, as disruption fades, assisted by recent government measures to support SMEs and exporters with GST compliance, real GDP growth will rise to 7.5% in FY2018, with similarly robust levels of growth from FY2019 onward.
  • Longer term, India’s growth potential is significantly higher than most other Baa-rated sovereigns.

What is the significance of this Rating on Indian Economy?

India’s sovereign credit rating is undoubtedly a welcome recognition of the country’s enormous economic potential.

The ratings agency has said the reforms undertaken until now would advance the government’s objective of improving the business climate, enhancing productivity, stimulating foreign and domestic investment, and ultimately fostering strong and sustainable growth.

The significance of the Rating:

  • Rating will enable Government to borrow money from various sources.
  • Rating shows India worth as investment destination.
  • This will enable India to position itself as a destination for foreign direct investment.
  • It is undoubtedly a welcome recognition of the country’s enormous economic potential.

What are the constraints?

The high public debt burden remains an important constraint on India’s credit profile relative to peers.

  • At 68% of its GDP in 2016, general government debt in India is significantly higher than the 44% median for other similarly ranked economies.
  • Rating agency sees the debt-to-GDP ratio widening by about 1 percentage point this fiscal year to 69%.
  • Farm loan waivers by States, the Centre’s implementation of the pay commission’s award and even weaker tax receipts amid teething issues with the GST will create more fiscal burden.

Way Forward

The large pool of private savings available to finance government debt, the steps taken to enlarge the formal economy by mainstreaming more and more businesses from the informal sector, and measures aimed at improving spending efficiency through better targeting of welfare measures, as all broadly supportive of a gradual strengthening of the fiscal metrics over time.

For the economy to capitalise on this upgrade, the political leadership must stay the reform course.