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, among other things, promote productivity by removing barriers to interstate trade; improvements to the monetary policy framework; measures to address the overhang of non-performing loans (NPLs) in the banking system; and measures such as 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 labor market reforms, which rely to a great extent on cooperation with and between the States.
Most of these measures 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 6.7% 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.
AND PROVIDE GREATER ASSURANCE THAT GOVERNMENT DEBT WILL REMAIN STABLE
Moody’s also believes that recent reforms offer greater confidence that the high level of public indebtedness which is India’s principal credit weakness will remain stable, even in the event of shocks, and will ultimately decline.
General government debt stood at 68% of GDP in 2016, significantly higher than the Baa median of 44%. The impact of the high debt load is already 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 over time, with the weighted average maturity on the outstanding stock of debt now standing at 10.65 years, over 90% of which is owed to domestic institutions and denominated in rupees. This in turn lowers the impact of interest rate volatility on debt servicing costs since gross financing requirements in any given year are moderate.
In addition, however, measures which 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. Moody’s expects India’s debt-to-GDP ratio to rise by about 1 percentage point this fiscal year, to 69%, 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 revenue-broadening and expenditure efficiency-enhancing measures take effect.
REFORMS WILL CONTINUE TO STRENGTHEN INDIA’S INSTITUTIONAL FRAMEWORK
Government efforts to reduce corruption, formalize economic activity and improve tax collection and administration, including through demonetization and GST, both illustrate and should contribute to the further strengthening of India’s institutions. On the fiscal front, efforts to improve transparency and accountability, including through adoption of a new Fiscal Responsibility and Budget Management (FRBM) Act, are expected to enhance India’s fiscal policy framework and strengthen policy credibility.
Adoption of a flexible inflation targeting regime and the formation of a Monetary Policy Committee (MPC) have already enhanced the transparency and efficiency of monetary policy in India. Inflation has declined markedly and foreign exchange reserves have increased to all-time highs, creating significant policy buffers to absorb potential shocks.
Much remains to be done. Challenges with implementation of the GST, ongoing weakness of private sector investment, slow progress with resolution of banking sector asset quality issues, and lack of progress with land and labor reforms at the national level highlight still material government effectiveness issues. However, Moody’s expects that over time at least some of these issues will be addressed, resulting in a steady further improvement in India’s government effectiveness and overall institutional framework.
GOVERNMENT SUPPORT TO PUBLIC SECTOR BANKS MITIGATES BANKING SECTOR RISK, SUPPORTS GROWTH
Recent announcements of a comprehensive recapitalization of Public Sector Banks (PSBs) and signs of proactive steps towards a resolution of high NPLs through use of the Bankruptcy and Insolvency Act 2016 are beginning to address a key weakness in India’s sovereign credit profile.
While the capital injection will modestly increase the government’s debt burden in the near term (by about 0.8% of GDP over two years), it should enable banks to move forward with the resolution of NPLs through comprehensive write-downs of impaired loans and increase lending gradually. Over the medium term, if met by rising demand for investment and loans, the measures will help foster more robust growth, in turn supporting fiscal consolidation.
RATIONALE FOR THE STABLE OUTLOOK
The stable outlook reflects Moody’s view that, at the Baa2 level, the risks to India’s credit profile are broadly balanced.
The relatively fast pace of growth in incomes will continue to bolster the economy’s shock absorption capacity. And even in periods of relatively slower growth, as seen recently, stable financing will mitigate the risk of a sharp deterioration in fiscal metrics.
However, the high public debt burden remains an important constraint on India’s credit profile relative to peers, notwithstanding the mitigating factors which 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.
WHAT COULD MOVE THE RATING UP
The rating could face upward pressure 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. In particular, greater expectation of a sizeable and 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. Implementation of key pending reforms, including land and labor reforms, could put additional upward pressure on the rating.
WHAT COULD MOVE THE RATING DOWN
A material deterioration in fiscal metrics and the outlook for general government fiscal consolidation would put negative pressure on the rating. The rating could also face downward pressure if the health of the banking system deteriorated significantly or external vulnerability increased sharply.
GDP per capita (PPP basis, US$): 6,694 (2016 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 7.1% (2016 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 3.9% (2016 Actual)
Gen. Gov. Financial Balance/GDP: -6.4% (2016 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -0.7% (2016 Actual) (also known as External Balance)
External debt/GDP: 20.4% (2016 Actual)
Level of economic development: High level of economic resilience
Default history: No default events (on bonds or loans) have been recorded since 1983.
On 14 November 2017, a rating committee was called to discuss the rating of the India, Government of. The main points raised during the discussion were: The issuer’s economic fundamentals, including its economic strength, have not materially changed. The issuer’s institutional strength/ framework have not materially changed. The issuer’s fiscal or financial strength, including its debt profile, has not materially changed. The issuer’s susceptibility to event risks has not materially changed.