20 Nov 2017
SMERA believes that the sovereign ratings upgrade by Moody’s (from Baa3 to Baa2) is a significant affirmation of its confidence in the robustness and resilience of the Indian economy.
The upgrade reinforces SMERA’s view that there has been a steady progress in economic and institutional reforms and these will structurally improve the growth prospects of the economy in the medium to long term. In the aftermath of the subdued GDP growth figures for the second quarter of the current fiscal, there had been significant concerns on the sustainability of India’s growth engine. Moody’s upgrade in a way puts to rest some of these concerns.
While the economy has faced headwinds over the last one year due to demonetisation and the implementation of GST, it is well poised for a takeoff from next year. The rating upgrade is clearly going to benefit the economy with higher allocation of both global debt and equity funds to India apart from an expected reduction in the cost of overseas borrowings for corporates.
SMERA’s article "Case for a relook of India’s sovereign ratings” published from the CEO’s desk in May, 2017 had highlighted the drivers for a potential sovereign rating upgrade. India has witnessed structural improvement in the macroeconomic milestones such as the fiscal deficit, consumer price inflation, foreign exchange reserves and FDI inflows over the last few years. These aspects have put the Indian economy on a robust platform and increased its ability to absorb potential shocks. We continue to believe that India’s consolidated debt to GDP is manageable, given the lower proportion of external debt and further, the aggregate debt inclusive of private debt compares favourably with that of the larger economies. While India’s tax base as a proportion of GDP at 13% has been seen as a rating weakness, the implementation of GST and the various initiatives to increase the tax coverage is expected to translate into a steady improvement in the tax to GDP ratio.
The high level of bad debt in the banking system and its concentration among the public sector banks have also been seen as a factor constraining the sovereign rating. RBI’s policy moves (Asset Quality Review) prompting the banks for better disclosure and provisioning of bad loans and subsequently, the initiation of legal procedures for large corporate loans under National Company Law Tribunal (NCLT) are steps in the right direction for addressing this challenge. While the resolution of the large bad debts is still likely to be a time consuming process, rating agencies and investors would take significant comfort from the large Rs. 2.1 lakh Cr. bank recapitalisation plan announced by the government in October.
Surely, slow private sector investments in India have been a matter of worry and a visible constraining factor in the sustainability of growth and job creation in the economy for some time. The government has already started to take specific measures to boost growth with the bank recapitalisation package expected to strengthen lending activities of the public sector banks particularly in the infrastructure and the MSME segments.
Our further suggestions to the government include not just increased spending but targeted spending particularly in the infrastructure sector which can step up construction activities in the short to medium term and create jobs. A revival in the real estate and the MSME sectors through appropriate incentives for fresh investments should also be a focus area of the government given their potential to generate employment within a short time span.