With general elections in 2019, an overtly populist budget can cause a rethink. Hence, the fiscal numbers have to be monitored well to ensure that there are few slippages.
The upgrading of India’ sovereign rating by Moody’s, though not befitting the progress made and efforts put in by the government, is still a positive development as it comes after a hiatus of over 13 years. Ideally, the upgrade should have been by at least two notches given that the state of the economy has been strong and resilient for the last three years, with significant reforms not just announced but implemented. It can be hoped that if both these yardsticks are maintained on an ongoing basis, another upgrade should be on the table soon. India has been a star-performer for long on almost all macroeconomic parameters; this was, however, not accepted by global rating agencies at face value. Methodologies were changed for computing the GDP to bring it on par with what was globally followed, but that did not help either. There have been several questions raised by rating agencies on the issue of reforms, and it is here that the government has worked really hard. While the macros are there to be seen and compared, it is the latter which may have clinched the upgrade decision.
First, the biggest tax reform, GST (Goods and Services Tax), has been implemented without a flinch. The urgency shown and the political barriers crossed to make this happen has made this reform even more striking. Second, the IBC (Insolvency and Bankruptcy Code) is in place for tackling NPAs, and banks have been nudged to take action. There are already major cases which have been referred to the tribunal and the resolution process is in progress. Third, the power sector, which was in disarray with the state-owned SEBs running large losses, has been launched on a phase of transformation with the debt issue being taken head-on by the participating state governments. Fourth, the recent plan to recapitalise banks through both conventional and unconventional methods shows that the issue is being tackled to ensure that banks are adequately equipped to face the challenge of future growth in credit. Besides, to the extent that net worth of banks has come down, such capital will help them stabilise. Fifth, the rationalisation of delivery of public subsides was an achievement in efficiency with the UID (unique identity) scheme playing a major role. Sixth, conduct of monetary policy has been aligned to global practices with the MPC (Monetary Policy Committee) being in place and an inflation-target being set.
All these measures and more (FDI policy, labour reforms, fiscal targets, etc) have led to an improvement in India’s Ease of Doing Business score, as per the World Bank index. Hence, it appears that almost all major reforms that were advanced by the rating agencies have been implemented with some of them now in the final stages of fructification. If these reforms are combined with macroeconomic data for the last three years, there would be a strong case for a higher upgrade. India remains one of the fastest-growing economies. Inflation is low and monetary policy well aligned to this objective. Foreign investors prefer India (both FDI and FPI) as a destination while the rupee remains better placed than most currencies. The current account deficit is low and the overall balance of payments resulting in forex accrual. With the only concerns being NPAs (which are being addressed), fiscal balances (being maintained at 3.2% but with some accommodation) and private investment, this matrix is quite good. What does a higher rating mean for India? First, it is a vindication of all the policies implemented and measures undertaken by the government to put the system in place and address all concerns of rating agencies. Second, from the point of view of reputation the upgrade is something to be happy about though India is still underrated. As this comes at the time when the global economy is still in a tenuous state, it seems even more remarkable. Third, a better rating will help Indian companies access global markets on more favourable terms. Generally, the sovereign rating becomes a cap when interest rates are determined globally for overseas borrowers. Hence, a better rating would mean that cost would come down for better-rated companies. Alternatively, the swap rates would come down for these loans. Fourth, there could be a positive impact at the margin for foreign investors especially when the decision to allocate funds for any market or country is driven by the rating. This would need to be tested over time because despite being just about investment grade, India has attracted one of the highest quantities of FDI in the past as well as FPI which find attractive valuations notwithstanding the low rating.
How about the markets? The stock market has reacted well as was expected and would remain buoyant until the next event takes place in the country. Hence, the impact would be short-lasting. The G-Sec market has reacted well to begin with as the yield on 10-years GSec came down. However, this too would be for a limited period and will be driven more by the fundamentals of the market including possible action by RBI on interest rates in the December policy. The rupee too strengthened after this announcement which was in a way expected as a stronger rating means a stronger economy. However, here too there would be only a temporary impact, and it would be back to normal after a few sessions. Therefore, on the whole the impact of the upgrade will be limited and restricted to initial sessions only. While the upgrade was very much logical, it should be understood that it is only one notch up and hence while it does lead to enthusiasm, it should not result in ecstasy as it is still in the BBB category (it has moved from Baa3 to Baa2) and is two notches away from the conventional A category. The pace of reforms has to be kept up, with the tempo not slowing down. Further, with general elections in 2019, an overtly populist budget can cause a rethink. Hence, the fiscal numbers have to be monitored well to ensure that there are few slippages. While the rating of the sovereign does not really matter to the government as there are no foreign borrowings, there has always been a tendency to answer questions posed by these agencies. This helps, because it forces a nation to perform on all fronts, and this, at the end of the day, is good for the economy.
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