Wednesday, November 29, 2017
Moody’s upgrades India’s sovereign bond rating after 14 years
Moody's Investors Service has upgraded the Government of India's local and foreign currency issuer ratings to Baa2 from Baa3 and changed the outlook on the rating to stable from positive. Moody's has also raised India's long-term foreign-currency bond ceiling to Baa1 from Baa2, and the long-term foreign-currency bank deposit ceiling to Baa2 from Baa3. The short-term foreign-currency bond ceiling remains unchanged at P-2, and the short-term foreign-currency bank deposit ceiling has been raised to P-2 from P-3. The long-term local currency deposit and bond ceilings remain unchanged at A1. According to the Moody’s PR 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.
The decision to upgrade the ratings is underpinned by the expectation that continued progress on economic and institutional reforms will, over time, enhance India's high growth potential and its 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. In the meantime, while India's high debt burden remains a constraint on the country's credit profile, Moody's believes that the reforms put in place have reduced the risk of a sharp increase in debt, even in potential downside scenarios. 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. Measures include the Goods and Services Tax (GST) which among other things, is expected to 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 others which work towards fostering stronger institutions and a more formal economy.
Moody's expects real GDP growth to moderate to 6.7% in the fiscal year ending in March 2018 (FY2017-18). However, as disruption fades, assisted by recent government measures to support SMEs and exporters with GST compliance, real GDP growth is expected to rise to 7.5% in FY2018-19. Longer term, India's growth potential is significantly higher than most other Baa-rated sovereigns. While India's high debt burden remains a constraint on the country's credit profile, Moody's estimates that the reforms put in place have reduced the risk of a sharp increase in debt, even in potential downside scenarios.
The upgrade comes within five years of India being classified as one of the "fragile five" economies, struggling with high twin deficits in fiscal and current accounts. Since then a combination of policy decisions and external factors has worked in favour of an upgrade. The Finance Ministry has held on to the targets for fiscal deficit, while the current account has been bolstered by a period of low oil prices followed by a resurgence of global trade. India’s position in the World Bank’s Ease of Doing Business rankings jumped up by a record 30 notches to the 100th spot recently with relevant policy easing. The upgrade has been termed overdue by some as India was earlier in the same risk category as a number of economies with far worse macro-economic performance. Indeed a Bloomberg Economics model had predicted an upgrade based on the divergence between actual ratings and CDS implied credit ratings.
The sovereign rating is an indicator of the government’s ability to meet its financial obligations. Sovereign credit ratings give investors insight into the level of risk associated with investing in a particular country and also include political risks. An upgrade thus lowers the cost of borrowing for the sovereign as it is associated with lower risk. In Moody’s rating, scale, bonds rated Baa3 and above are considered to be investment grade, meaning, these bonds are likely to meet the payment obligations better. India was at the lowest rung of the investment grade until it received this upgrade. The Indian government, it may be noted, does not fund its deficits via offshore commercial bond markets. External debt as a percentage of the Central Government’s total liabilities was at 6.2% in 2015-16. The entire public debt of India is funded via the domestic Rupee (INR) bond market. Foreign investor participation in the bond market, though increasing is very little, and tightly regulated through quotas. However, there are certain other benefits to be derived from a sovereign upgrade.
Sovereign ratings also act as the benchmark for other issuers of debt in the country. Effectively, sovereign upgrades or downgrades can affect borrowing costs for companies, individuals and any entity looking to raise money overseas. Moody’s upgraded some Indian corporate entities, mostly public sector companies along with the sovereign upgrade. This would result in reduction in cost of borrowing for Indian companies looking to raise financing from offshore bond markets. In fact, Reliance recorded the tightest ever spread for an Indian issue over US Treasuries in the offshore market soon after the upgrade.
The sovereign rating is an important indicator of the country’s financial and fiscal health. Foreign investors looking to commit money to direct investments, portfolio investments or local bond markets will all tend to look to the sovereign rating for a quick assessment of the country’s prospects. A ratings upgrade gives out a positive view on policy and builds incremental confidence in foreign investors. A higher rating can increase the range of investors, for example, drawing in global Pension and Life Insurance firms that have minimum ratings criteria for investing. Incrementally higher foreign flows tend to bid up INR too, making investments in a host of other Indian financial assets like equities and real estate more attractive to foreign investors.
—and the caveats
Moody’s mentions that 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. The upgrade has come in at a time when a gamut of short and long-term indicators has started to worsen. Given the emerging signs of quickening inflation and a widening current account and fiscal deficit a lot of policy balancing is in order.
S&P Global Ratings and Fitch Ratings, who now rate India a notch below Moody’s, hold the view that for an upgrade, India would have to address its weak fiscal balance sheet and weak fiscal performance. S&P Global Ratings, while acknowledging India’s stronger growth prospects and the country’s achievements on the reforms agenda, noted that its ratings were constrained by India’s low wealth levels, measured by GDP per capita. This and the income inequality hidden behind it, is indeed a macro-economic indicator which, on its own, needs far greater policy attention and careful planning than it has received so far.