Rating agency Moody’s on Tuesday revised its outlook on the Indian government’s local currency rating from stable to positive, a signal of its greater confidence in the economy’s early return to a high-growth path without impairing its debt profile.
“This ratings action reflects the better prospects for the Indian government’s credit metrics in the medium term,” Moody’s senior analyst Aninda Mitra told DNA.
“The country’s growth prospects remain intact despite the global recession, and the underlying structure of the economy remains robust.” And despite the “large” fiscal deficits, “we don’t expect the government’s debt ratio to deteriorate significantly,” he added.
All this, noted Mitra, provided the Indian government “the opportunity to formulate a well-crafted exit strategy…. We think the medium-term stage is being set for an orderly winding of the stimulus, which could potentially be consistent with the government’s fiscal responsibility commitments.”
Local currency ratings reflect Moody’s opinion on the capacity and willingness of a government to raise resources in its own currency to repay its debt to bondholders on a timely basis. The key question is the extent to which a government is able and willing to alter — if and when necessary — its balance of income and spending in order to generate enough resources to repay the debt on time.
Moody’s latest action narrows the gap between the Indian government’s foreign currency bond ratings — which remain stable at Baa3 — and the local currency rating, which is slightly lower at Ba2. Mitra noted that Moody’s had long held the view that given the “exceptional strength of India’s external position,” a foreign currency government debt instrument was less risky than a local currency debt instrument.
“What we are now suggesting is that that gap can be narrowed with an upward movement in the local currency bond ratings of the government because India’s economy and the growth model continue to integrate with the rest of the world and its growth prospects remain intact,” he added.
Mitra noted that relative to other emerging markets, India’s “ability to finance its large deficits has been proven.” And unlike many other countries that are running large deficits, India’s debt profile “is not sharply deteriorating, and there’s an element of sustainability and a deep savings pools which are assisting finance-ability of its deficits.”
Yet, that can be infinitely sustained “if the government keeps running very large budget deficits… So we’ll be looking at the nature and extent of the exit strategy that the government will be formulating.”
More specifically, “the government needs to run a budget deficit that is consistent with a gradually declining debt to GDP ratio - if not a rapidly declining ratio,” Mitra added.
“Will such policies be derived from the recommendations of the Fiscal Responsibility and Budget Maintainence Act, and will they act as guideposts…These are the sorts of things we will be looking at very closely.”
The outcome of the next phase of India’s fiscal responsibility act, and the precise nature and extent of the government’s fiscal consolidation program would be critical in determining the near-term course of changes in sovereign ratings, Mitra noted.
“A convincing approach whereby the benefits of economic growth better translate into lower debt metrics will be key to our judgment.”
Barclays Capital analyst Rahul Bajoria noted that the change in Moody’s outlook was “unlikely to have an immediate impact.” Yet, the positive sentiment on local currency debt, coupled with a “robust external position”, had the potential to “gradually spill over into the foreign currency bond ratings (which were last revised in January 2004), provided fiscal consolidation continues to take shape in India over the next 12 months.”
Bajoria further noted that it had become “increasingly likely” that India’s fiscal position would improve in financial year 2010-11.
“Despite the government proposing a spending increase, it has indicated that it remains confident that its fiscal deficit target of 6.8% will not be breached.” And since revenues from tax and the divestment program were “likely to surprise on the high side”, the fiscal deficit for FY 2009-10 and FY 2010-11 were likely to be around 6% and 4.8% of GDP, respectively.
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