Earlier this month (Feb 3), Moodys Investors Service upgraded Indias foreign currency credit rating to Ba1 from Ba2. At Ba1, India is now at the top of the speculative category, just a notch below investment grade, and is one of the few sovereigns (others being Turkey and Japan) to which Moodys has assigned a higher rating on foreign currency than on local currency government debt (Ba2).
Japans fiscal deficit and debt-to-GDP ratio is much higher than Indias. But just like India, much of the indebtedness is mostly domestic. When the government owes a lot of money to its own people, it is like the left pocket owing money to the right pocket. Additionally, governments can always print more money to pay off domestic debt, which they cannot do for foreign debt. That is one reason why the US is never worried about its external debt, since it is mostly in dollars anyway!
Moodys rating on foreign currency is taken to be the sovereign rating. Another international rating agency, Fitch, also affirmed Indias long-term foreign currency and local currency ratings at BB and BB+, respectively. Moodys rating upgrade, however, comes only four months after Standard & Poors downgraded the governments local-currency debt to junk status. S&Ps downgrade was by one notch, to BB+ from BBB minus. As a general principle, unlike Moodys, S&P does not assign a higher rating to foreign currency than domestic currency. Its rating on India at BB has been unchanged since 1998. There is, however, an anomaly.
The current BB rating of S&P is worse than what it was in the middle of crisis year of 1991. Indias net foreign debt is only 40 per cent of current dollar receipts, as against 300 per cent in 1991. Surely, the situation of huge reserves, current account surplus, low external debt and declining debt service ratio is not worse than 1991, when reserves fell to a few weeks worth of imports Today, India could pay off all her external sovereign debt this year, if she so desires. Hence it would be interesting to watch whether Indias debt situation forces S&P to abandon their policy of not upgrading.
On its part, S&P has been steadily moving India down for its domestic debt. Its previous downgrade was a year ago in August 2001, when it lowered the rating to BBB minus from BBB. Indias fiscal deficit may not be the worst in the world (Lebanon had 24 per cent deficit ratio recently, Zimbabwe has been at 22 per cent), nor is her debt-to-GDP ratio the highest (Japan, Argentina, Indonesia, Egypt etc are all much higher). But the persisting deficit, with a rising revenue deficit, and worsening states fiscal affairs is like a slow poison. Even though inflation remains benign and interest rates are low, there is a slow deceleration in growth rates in the past couple of years.
Indias external and internal debt provides a yin and yang contrast, sort of like the horror story of Dr Jekyll and Mr Hyde. We are cheerful of external rating, but ignore warning on internal rating. Granted that the domestic debt is not yet a horror story, but it is like slow poison. And short-termism which postpones the problem to tomorrow every year will make us like the frog who didnt realise till too late, that it was in boiling water! And thats a horror story.
The author is Chief Economist, ABN Amro Bank, India