New Delhi: Global agency Moody's on Tuesday said it will upgrade India's rating if the government is able to push through reforms, inflation stabilises, regulatory environment improves and infrastructure investment rises.
"India's rating could be upgraded if Moody's expectations of gradual but credit positive reforms are realised in actual policy implementation and if the recent improvement in inflation, fiscal and current account ratios is sustained," Moody's Investors Service today said in a report.
The agency said that it had changed its outlook on India in April to positive from stable, based on premise that the proposed policies are likely to lower sovereign credit risk by stabilising inflation, improving the regulatory environment, increasing infrastructure investment while maintaining the ongoing improvement in fiscal ratios.
It has a 'Baa3' rating on India with a positive outlook. Since 2004, Moody's has rated India at 'Baa3', the lowest investment grade ?- just a notch above 'junk' status.
The rating could be upgraded if these expectations "are reflected in policy progress and macroeconomic indicators over the next year, and if we view this progress as sustainable."
But the rating outlook would likely return to stable if there was "a slowdown or reversal of the policy reform process, if banking system metrics continue to weaken, or if there is a decline in foreign exchange reserves coverage of external debt and imports," it said.
It said lower oil prices as well as tighter fiscal and monetary policies have helped restore macroeconomic balance.
"But the consequence of tighter policies is that GDP and investment growth are likely to remain at levels that are lower than their peaks of a decade ago. Nonetheless, GDP growth -- which we forecast at 7 percent this year -- is still likely to surpass the average for its peers, as it has over the last decade," it said.
Stating that the Modi government has made some progress on reforms to improve the operating environment and ease investment procedures, Moody's said the progress has stalled in two key areas -- passing a unified Goods and Services Tax (GST) and the Land Acquisition Act.
The Moody's statement came a day after the stock market benchmark Sensex crashed by 1,624.51 points - its biggest single-day fall - and over Rs 7 lakh crore got wiped out within hours from the investors' wealth.
"While the government had hoped to pass the unified GST during the monsoon parliamentary session, failure to do so despite cross-party support for the measure is an indication of the government's challenges to overcome political gridlock in order to pass major structural reforms," Moody's said.
Over the last year, performance on inflation and the balance of payments have improved, reflecting policy efforts.
"However, a sustained improvement in its relative ranking on competitiveness indicators will depend on the extent to which the government's stated commitment to improving the operating environment is reflected in infrastructure and regulatory conditions," it said.
Stating that its positive outlook on India's rating was based on view that authorities are making efforts to address some of these institutional constraints, Moody's said it does not expect these efforts to result in a shift in governance or growth indicators in the near term.
"If these efforts are successful, however, stronger institutions are likely to also result in an improved operating environment for investment and growth, over a three to five year period," it said.
Ranking India's institutional strength as moderate relative to other countries in the Moody's-rated universe, it said institutional strengths were apparent in the nation's robust democratic apparatus, including freedom of the press, and an entrenched system of checks and balances among government branches.
Moody's said World Bank Governance Indicators form part of its assessment of institutional strength.
India's performance on political stability, regulatory quality, control of corruption and government effectiveness is weaker than the median for sovereigns rated in the Baa range, as well as sovereigns assessed as having moderate institutional strength, it said.
"Since taking office in 2014, the Modi government has announced several initiatives to improve governance and government effectiveness.
"Plans include improvements in infrastructure delivery, a reduction in time to obtain regulatory approvals, a simplified tax regime, an enhanced food distribution system, and subsidies delivered through direct cash transfers, among others," it said.
The nature of these improvements is such that, even if they are successfully implemented, "their impact may only become evident, whether through economic indicators or survey data on government effectiveness, over a two to three year period," it said.
Without a shift in the composition of expenditure, India will continue to have very limited fiscal flexibility to implement counter-cyclical policies and developmental reforms, and any deficit widening due to a revenue growth slowdown will also contribute to inflation and balance of payments pressures as was the case during the 2011-2013 slowdown, it said.
Moody's said the institutionalisation of the inflation targeting framework is a work in progress, with issues like the specific powers and composition of the monetary policy committee still under discussion.
It assessed government financial strength as low relative to other sovereigns in the Moody's-rated universe, reflecting fiscal deficit and debt ratios that are higher than in similarly rated sovereigns.
"Our assessment also incorporates our expectation that, despite improving over the last decade, the government's debt and interest payment burden will remain high relative to its annual revenues, due to structural factors outlined later in this section," it said.
Moody's said its assessment recognises that the currency and maturity structure of government debt, its largely domestic ownership, as well as the differential between growth and interest rates in India, mitigate some of the credit risks associated with high deficit and debt ratios.
The government's fiscal position has a negative macroeconomic impact because it limits its ability to spend on much needed social and physical infrastructure.
It also hampers fiscal flexibility to respond to future shocks. Moreover, the government's relatively high annual borrowing needs crowd out private investment by raising private-sector borrowing costs and lowering access to domestic savings.
Stating that macroeconomic indicators have improved over the last few years, Moody's said deficit has been lowered to an estimated 6.6 percent of GDP in FY2015 from 8.1 percent in FY2009, while government debt dropped to 65.2 percent of GDP from 71.5 percent over the same period.
In addition, inflation and the current account deficit- to-GDP ratio have also declined to 5.3 percent and 1.4 percent in 2014, from recent peaks of 10.5 percent and 4.8 percent respectively in 2012.
It said the consequence of tighter policies is that GDP and investment growth are likely to remain at levels that are lower than their peaks of a decade ago.
It said the government's efforts to revive private investment, particularly in manufacturing, appear to be key to a sustainable growth recovery.
"If successful, an acceleration in manufacturing investment will also alleviate the economy's current vulnerability to fluctuations in agricultural output, which makes up 17 percent of GDP, but a much higher proportion of employment," it said.
