Here is the fact about rating Baa3 of India which is given by Moody's. Moody's has given stable outlook to the Indian Economy based on the various factors. Here are the FAQ for providing India's Sovereign Rating.
Why is Moody’s outlook on India’s sovereign rating stable when GDP growth has decelerated?
Moody’s sovereign ratings are a global ranking of relative creditworthiness, based on the
ability and willingness of the sovereign to meet its debt obligations, compared to other rated
sovereigns. Every rating incorporates an analysis of many different quantitative and
qualitative factors outlined in our sovereign rating methodology, including but not limited to
GDP growth.
At any given time, there could be largely positive or largely negative trends in one or more
credit-relevant metrics in any country. We would change the sovereign rating outlook on
that country when we believe that these (positive or negative) trends:
» Go beyond what is already incorporated into the current rating
» Will persist over the medium term
» Are strong enough to change the sovereign credit profile to such an extent that, over the
next 12 to 18 months, this credit profile would not be compatible with its current rating
and with those of other sovereigns that currently have the same rating.
Following from the above, we maintain a stable outlook on India’s rating because:
» 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, although we do expect that global and domestic factors will keep India’s growth
below trend for the next few quarters.
» 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.
» India’s growth slowdown is neither unique nor irreversible. Deceleration in Indian growth is
similar to that experienced in other countries.
To summarize, our ratings express a view on medium term creditworthiness and do not generally
change with fluctuations in growth related to the direction of the business cycle at a particular point in
time, if we expect growth to recover and sustain over time. We were not convinced that the Indian
economy could sustain 9 - 10% growth over the medium term, given India’s structural constraints,
even though India enjoyed those growth rates between 2005 and 2007. Similarly, we are not
convinced that India’s medium term growth potential has dipped dramatically from approximately 7%
levels, although we expect economic growth to be well below this level in the near term, due to
depressed business sentiment, potential agricultural shocks, tighter financial conditions and global
volatility.
Moody’s Sovereign Methodology includes an assessment of all rated countries’ economic strength on the following scale: very high/high/moderate/low/very low. We view India’s economic strength as moderate relative to other rated countries and events in the last few quarters have not changed this assessment, which incorporates both credit strengths and weaknesses. Credit strengths such as the very large size and diversity of the Indian economy, its higher than peer-average growth rates, robust savings rates, and a fairly dynamic, internationally competitive private sector are constrained by high rates of poverty and inequality, weak social and physical infrastructure and a relatively difficult operating environment.
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. Per our rating methodology, we evaluate 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.
Recent trends have validated this assessment.
» Since fiscal policy also serves to maintain social stability in a highly diverse, poor and unequal
society, India’s budgets are likely to remain in deficit until these underlying socio-economic
weaknesses are alleviated. This poverty constraint is effectively factored into the rating by
assigning India a ‘moderate’ economic strength assessment, despite the well-above global average size and growth rates of its economy.
- Low per capita income and widespread poverty limit the amount of revenue that the
government can collect in the form of personal income tax, hence the reliance on profit,
output and consumption taxes. In addition, shortcomings in the area of tax compliance limit
the gains to government revenue from a surge in income growth.
- At the same time, poverty and inequality make it difficult to cut social services and subsidies
in order to reduce the deficit. Although there have indeed been modest attempts to cut
fertilizer and fuel subsidies over the last two years, they haven’t been enough to dent the
deficit or compensate for the increased spending commitments on food subsidies.
» India’s deficits reveal a greater vulnerability to growth downturns compared to other similarly
rated countries. Therefore, it is not surprising that a growth slowdown has also led to missed
budget deficit targets. Fiscal vulnerability lies partly in the government’s reliance on corporate
profit and consumption taxes, which are highly growth-elastic. On the other hand, nondiscretionary expenditures like pensions and interest payments consume much of the Indian
budget, so the government has little room to cut expenditures when revenues decline. Therefore,
fiscal metrics have deteriorated substantially with every dip in corporate profits and private
consumption. As Exhibit 3 reveals, the current trend in the fiscal deficit echoes what happened
during the last cyclical slowdown between 2000 and 2003. Conversely, fiscal metrics improved
with the cyclical upturn, when they also coincided with efforts at fiscal consolidation.
» 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.
» Recognizing the socio political constraints on government financial strength, and the cyclical
aspect of recent fiscal deterioration, a look at past trends suggests that there is still the possibility for fiscal consolidation in India. After averaging 9.3% of GDP for four years between 1999 and 2003, India’s general government deficit fell to under 4% of GDP in FY 2007/08, due to strong revenue growth and relative expenditure restraint. However, consolidation is generally adopted (and more successful) when growth conditions are benign. Therefore, looking ahead, we expect that the government will attempt to boost revenues or streamline expenditures, albeit modestly, at a politically and economically expedient time. Given the now well-established link between loose fiscal policy and inflation, there may be an added impetus to curtail fiscal expansion that leads to economically and politically harmful inflationary trends.
» Large fiscal deficits have led to a relatively high level of public debt. Although government debt
has been increasing in rupee terms, it has declined as a percentage of GDP – from 88% in 2005-
06 to 71.9% in 2011-12, as shown in Exhibit 3. Part of this decline was due to robust growth
during those years; however high inflation has also buoyed the denominator and contributed to
lowering the ratio.
» The composition and maturity structure of government debt allows its high level to be sustained.
The government’s debt is mostly long term and held domestically, which lowers the refinancing
and exchange rate risks inherent in short term, externally financed debt.
To summarize, given the greater vulnerability of Indian public finances to cyclical fluctuations, the
missing of the budget deficit target in a year of sub-par growth was anticipated in our credit analysis.
Looking ahead, the political economy constraints on fiscal policy will likely keep India’s fiscal metrics in a poorer state than those of similarly rated countries.
This weaknesses is incorporated into our Baa3 rating, along with credit strengths such as a higher than average domestic savings rate which helps absorb government debt issuance and the positive differential between India’s real growth rates and the real interest rates paid on government debt, which sustains the high debt burden. Having said that, we have also emphasized in previous publications that the failure to narrow persistent government deficits could endanger India’s credit strengths. Loose fiscal policy nourishes inflation. Persistent inflation, in turn, erodes the value of accumulated savings. It also raises capital costs and discourages investment. Moreover, high domestic interest rates prompt the private sector to borrow abroad, and increase economic vulnerability in times of global financial volatility.
Therefore, the stable outlook on India’s rating is predicated on our expectation that there will be some, if modest, policy effort to curtail the primary deficit over the medium term, although a turnaround in current fiscal trends is unlikely without a turnaround in growth.
Is rupee depreciation negative for the sovereign credit profile?
The rupee has depreciated by over 20% over the last year against the US$, 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.
Indian firms that have large foreign currency repayments due this year will suffer from depreciation.
However, since the government has not guaranteed private-sector foreign debt, possible private-sector credit stress does not impinge upon the sovereign – and won’t unless asset quality in state-owned banks worsens, due to depreciation-induced stress, to a degree that requires government support for the banks.
More importantly, India’s total private sector external debt is a relatively low 16% of GDP. Therefore, individual firms’ foreign debt repayment troubles are unlikely to lead to the sort of domestic demand collapse or deleveraging seen in countries with more significant private-sector external leverage. Since official foreign currency reserves are well over 100% of the country’s total debt repayment needs over the next 12 months, continued balance of payments volatility will be much less damaging than in 1991, when low reserves and a widening current account deficit prompted India’s last balance of payments crisis.
Depreciation could help correct some macro-economic imbalances….
The rupee’s performance is linked to global volatility as well as India’s own macro-economic
imbalances, including loose fiscal policy, which has boosted domestic demand, inflation, and import spending and government subsidies, which support India’s reliance on imported commodities. These factors widened India’s current account deficit to about 4% of GDP in December 2011 from 2.6% of GDP in March 2011. For most economies, reversing such a trend requires one or more of the
following:
» Exchange rate depreciation to encourage exports and discourage imports
» Fiscal consolidation that subdues domestic demand and hence imports
» Structural reforms that improve international competitiveness
Since the Indian government’s political capacity to implement fiscal and structural reform is weak, a flexible exchange rate can still serve as a policy tool, allowing depreciation to correct external
imbalances. Historical experience has shown that depreciation can have positive effects on correcting macroeconomic imbalances and boosting growth for fundamentally competitive economies, which we think India is—notwithstanding recent growth deceleration.
…But rupee weakness could persist during a period of global volatility
The current global growth and capital market environment will limit any credit positive implications
of currency correction. First, it is likely that any narrowing of the trade deficit following depreciation will be more the result of import deceleration (helped by lower oil prices more recently) than export acceleration over the next two to three quarters in light of subdued global demand. In that case, lower GDP growth will accompany balance of payments improvements, a necessary short-term cost to avoid a more severe crisis and to repair the current account deficit over the next 12 months. Second, a lower current account deficit is unlikely by itself to reverse rupee depreciation as long as global portfolio flows remain volatile.
How do you incorporate the policy environment into the sovereign credit
analysis?
We evaluate 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.
As noted in the response to the question on growth, we believe that 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. Along with poor public finances, central government policy action and inaction constrains India’s rating at the Baa3 level. Specific policy constraints include:
» The government’s inability to accelerate the provision of social and physical infrastructure – either
itself or by allowing private sector participation
» Regulatory restrictions and complexities which thwart private investment, particularly FDI
» An uncertain tax environment which makes long term planning difficult, and so subdues
investment.
» Corruption and administrative inefficiency impinging upon project implementation
These constraints, which have existed for decades, have not prevented cyclical acceleration when global growth was flourishing, international capital was easily available, and a more benign domestic inflationary environment allowed monetary policy to be more aggressively counter-cyclical.
Over the past year, however, market-unfriendly policy actions, such as changes to the tax regime for foreign investors as well as a reversal on foreign investment allowed in the retail sector, have further dampened business sentiment that was already deteriorating because of global uncertainties and tight financing conditions. While the government’s specific recent announcements may have been unanticipated, their impact on growth – by lowering investment intentions – was foreshadowed by our long held view that the central government’s policy framework is a credit constraint.
However, central government policy is only one aspect – albeit an important aspect – of the overall institutional and policy environment that affects sovereign creditworthiness. Recent investment behavior has shown that India’s state level policies can be important determinants of growth. This is apparent not only in the differing levels of growth observed in Indian states that promote investment friendly policies, but also differentials in terms of infrastructure and living standards. Voting behavior at the state level suggests that good economic outcomes are rewarded, which in turn implies that where growth-friendly policies are in place, they are likely to persist, and where they are not in place the demonstration effect may result in their adoption. In our view, given India’s vast market and its potential, as well as the efforts being made by some state governments to woo investment, a few illconceived recent policy proposals by the central government are unlikely to derail India’s investment growth over the medium term.
Another aspect of the policy framework is the monetary policy and financial supervision conducted by the Reserve Bank of India. During the global financial crisis, the Indian financial sector’s relative insulation was partly attributed to the central bank’s supervisory role. The RBI has also vastly increased its transparency with regard to monetary policy, leading to greater policy predictability and credibility.
The RBI’s decision to eschew exchange rate defense in favor of preserving reserves was credit positive: exchange rate flexibility allows for the correction of macroeconomic distortions that loose fiscal policy begets; maintaining a significant reserve buffer guards against the balance of payments volatility that current global uncertainties create. Demonstrated monetary and financial supervisory vigilance supports the sovereign credit profile.
What could change the rating down?
The following developments would put downward pressure on India’s rating:
» 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.
Substantially lower growth for a number of years would leave the government’s debt burden less
sustainable than it is now.
» Fiscal policy actions that continue to pile up long term expenditure obligations, without
compensatory revenue measures. As we have noted, we expect a growth upturn and modest fiscal consolidation measures to lower the budget deficit and debt ratio over the next few years.
However, this expectation would be derailed if policy remained expansionary during the recovery,
or created long-term liabilities beyond what can be expected as part of pre-election populism.
» Greater than anticipated stress in the banking sector would also exert downward pressure on the government’s rating. Government ownership of the country’s largest banks represents a contingent liability, should those banks experience significant credit stress themselves that requires government support. Moreover, banking system stress would also hurt growth, as well as savings intermediation (since about half of all household financial assets are held by the banking system).
What could change the rating up?
As mentioned in previous sections, 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. Efforts to address these constraints along with evidence that these efforts are both effective and will be sustained could lead to upward rating momentum.
Source: Moody's Report
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