"We expect India's Sovereign Rating to remain stable in the next 12 months period. Decisive and timely action by the government to reduce the fiscal deficit through lower expenditure, moderate rural wage growth in line with productivity, and reduced energy subsidies would be needed to trigger an upgrade," Morgan Stanley said.
India's sovereign is currently rated BBB- by all rating agencies; only S&P has India on a negative outlook. While the rating agencies do not detail specific triggers for a downgrade, S&P is looking for stronger growth, fiscal account consolidation and lower inflation to revise the outlook to stable.
While India scores well for variables, such as GDP growth and FX reserves/GDP on Morgan Stanley forecast, it needs to show considerable improvement in inflation, fiscal balance and current account deficit to potentially be upgraded.
Morgan Stanley economics team expects India's inflation rate to be reduced to 6.5 per cent over the next 12 months. While this is an improvement from the current level, it still compares unfavourably with the average BBB-rated EM sovereign (4.8 per cent), and average EM sovereign rated A and above (2.6 per cent).
Similarly, India's fiscal balance expectation (-6.4 per cent of GDP) compares unfavourably with EM sovereigns rated BBB (-1.9 per cent of GDP) and A (-2.1 per cent of GDP).
The factors like reforms to target reducing inflation, cutting the fiscal deficit, and encouraging FDI inflows to boost productivity and improving growth, is critical for achieving the government's aim of sustainable and higher growth. If these key areas are targeted effectively, it would not only boost productivity, but also improve the credit rating for the sovereign, the report said.
A pick-up in economic growth and rising private capital needs will be important drivers for Indian credit markets.
"We expect the size of the Indian USD/G3 bond market to reach USD 160 billion by 2018, driven by non-financials. Economic growth and capital needs will be important, but the key driver will be a gradual increase in reliance on debt capital markets. On average, the Indian USD/G3 bond market should see annual gross issuance in excess of USD 25 billion in the years to 2018," the report said.