India’s sovereign rating

Moody's Investors Service on Monday said it was maintaining a stable outlook on India's sovereign credit rating. It said that credit challenges such as weak fiscal performance, inflationary trends and uncertain investment policy environment have been part of the Indian economy for decades and were therefore previously built into India’s current Baa3 rating.


However, it said that some recent negative trends, among them lower growth, slowing investment and poor business sentiment, are unlikely to become permanent or even medium-term features of the Indian economy.
At the same time, it cautioned that global and domestic factors, including potential shocks in agriculture, could keep India's growth below trend for the next few quarters.

India’s GDP growth slowed to 6.5 per cent in fiscal 2012, while GDP growth for the March quarter fell to a paltry 5.3 per cent, the lowest in nine years. Additionally, the fiscal deficit for the current fiscal has been pegged at 5.1 per cent of GDP, after having climbed to 5.9 per cent in FY-12 from a projected 4.6 per cent.

Here are some frequently asked questions about India’s sovereign rating:

Q1. Why is the outlook stable when growth as decelerated?

Some negative aspects—such as weak fiscal performance, tendency towards inflation, uncertain investment policy environment—have characterized the Indian economy for decades, and are already incorporated into the current Baa3 rating. On the other hand, other negative trends—such as recent low growth, slowing investment and poor business sentiment—are unlikely to become permanent or even medium-term features of the Indian economy.

The impact of lower growth and still-high inflation will deteriorate credit metrics in the near term, but not to the extent that they will be incompatible with India’s current rating. Also,  India’s growth slowdown is neither unique nor irreversible, and deceleration in Indian growth is similar to that experienced in other countries.

Q2. Are deteriorating budget deficits incorporated into the rating outlook?

India’s government debt and deficit ratios are worse than those of most similarly rated countries, and always have been. Moody’s says it has evaluated the Indian government’s financial strength as low (on a scale that ranges from very high/high/moderate/low/very low). However, this assessment was based not merely on a comparison of the relative level of government debt and deficit ratios, but on the underlying reasons for relatively high deficits, which suggest that India’s fiscal deficits will remain above peer averages in the medium-term and will widen substantially with every dip in growth.

The Indian budget is also exposed to global volatility since India’s food, fertilizer and petroleum subsidy spending is exposed to commodity price and exchange rate trends, both of which have inflated expenditure during the last few years. 

Q3. Is rupee depreciation negative for the sovereign credit profile?

The rupee has depreciated by over 20% over the last year against the dollar, in conjunction with a widening current account deficit and lower capital inflows. However, since government foreign currency debt comprises only 5.3% of total government debt and is equivalent to 3.8% of GDP, depreciation does not increase the government’s own debt service burden significantly, especially since most of its debt is owed to multilateral and bilateral creditors and has a maturity profile that keeps annual foreign currency repayments relatively low.

Q4. Where does the policy environment come in?

Moody’s evaluates India’s institutional strength as moderate (on a 5-point scale ranging from very high to very low), to encompass a range of operating environment characteristics, including security of property rights and contracts, access to judicial redress, regulatory and policy certainty, financial supervision, monetary policy effectiveness, and administrative efficiency.

Moody’s says the investment policy environment in India is a credit weakness, which diminishes the potential growth rate that the economy would otherwise achieve, given favorable demographics, private sector dynamism and increased integration into global production networks.

Q5. What could change the rating up or down?

There is evidence that the structural drivers of India’s growth potential—high savings and investment rates, favorable demographics, private sector competitiveness—have been eroded to such an extent that India’s medium term growth rate will no longer exceed the global emerging market average. Also, fiscal policy actions continue to pile up long-term expenditure obligations, without compensatory revenue measures. There is also greater-than-anticipated stress in the banking sector, which would exert downward pressure on the government’s rating.

As regards what could improve the rating, Moody’s says India’s Baa3 sovereign rating is constrained by the government’s weak financial position, the country’s weak social and physical infrastructure, and the dampening of potential investment growth due to the central government’s policy framework, and efforts to address these constraints along with evidence that these efforts are both effective and will be sustained could lead to upward rating momentum.
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