The move by Moody’s Investor Servies, the credit rating agency, to reiterate its Baa3 rating comes as a big relief to the UPA government, which is trying to drive the economy faster while simultaneously attempting to reduce the fiscal deficit.
But the rater cautioned high fiscal deficit could pull down growth in the coming years.
Baa3 indicates investment grade, with a stable outlook.
A downgrade would have meant the so-called ‘junk’ status. It essentially would mean interest rates go up for those who borrow abroad, and, more importantly, foreign funds’ exit from India if their investor mandate is that they can’t invest in junk-rated countries.
“Government finances are the weakest aspect of India’s macroeconomic profile... We expect the government’s fiscal position to remain weaker than peers over the medium term,” Moody’s said, but added a sustained improvement in public finances could result in rating upgrade.
“They have basically reiterated the rating. Remember, Moody’s rivals Standard & Poor’s and Fitch Ratings have only scaled India’s outlook lower – they have not downgraded the sovereign,” points out Gaurav Kapur, senior economist at Royal Bank of Scotland.
According to economists, Moody’s understands that while there’s a structural side to the India story, the overall long-term growth story remains fairly strong. Given that India’s debt is largely domestic, it’s unlikely servicing debt is a problem, they believe.
“As long as nominal GDP (GDP + inflation) is higher than the interest rate that the government pays on its bonds, the debt can be serviced without much problems. This is especially true in the context of what’s happened in Europe, where growth slowed down sharply and interest rates went up, landing a double whammy,” Kapur said.
But, analysts say, the crucial problem for India remains outside its borders – the current account deficit, which, at 5.4%, is a significant problem.
In the last two years or so, India’s international trade position has weakened as imports increased far more than exports leading to a big deficit in the current account. Exports have fallen because the economies in the American and European continents are extremely sluggish.
“Ultimately critical to the recovery is a stronger currency and lower interest rates, both of which can be achieved by a pick-up in capital flows. And the government understands that, and it’s trying to do the best it can,” said another economist with a domestic brokerage, who did not wish to be named.
“To me,” says Kapur, “the economy has well and truly bottomed out. The bigger challenge remains the current account deficit because it affects India at multiple levels – there will be more stress on corporate balance sheets, more stress on the rupee, it keeps inflation expectations high and it also affects the fiscal deficit due to the oil issues.”
As regards growth prospects, Moody’s said a downturn was underway which could be exacerbated by slower global growth.
However, robust domestic savings and a dynamic private sector would provide strength in the medium-term to India, the rater said.
It expects the economy to grow by 5.4% in the current fiscal and 6% in the next. With agencies