‘Don’t expect India’s debt to fall to pre-pandemic level anytime soon’: Interview: William Foster, V-P and senior credit officer (sovereign risk), Moody’s Investors Service

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Updated: June 02, 2021 11:44 AM

At this stage, we expect negative sequential economic activity to be limited to the April to June quarter, with annual real GDP growth of 9.3% in the fiscal year ending March 2022 and 7.9% the following fiscal year.

Somewhat slower growth due to the second wave and higher fiscal deficits will result in a higher debt burden.Somewhat slower growth due to the second wave and higher fiscal deficits will result in a higher debt burden.

William Foster, vice-president and senior credit officer (Sovereign Risk) at Moody’s Investors Service, tells FE’s Banikinkar Pattanayak that India’s elevated debt levels will inflate interest payments. Over the medium term, prospects for the debt burden to drop have diminished and will significantly hinge on nominal GDP growth trend: Edited excerpts:

Moody’s has predicted that India’s general government debt burden will rise to 90% of GDP in 2021-22, gradually inching up to 92% in 2023-24. This means even with a pick-up in the growth rate, debt level won’t come down anytime soon. Why so?

The spread of the second wave and re-imposition of lockdown measures has curbed economic activity and mobility in India, which will delay the economic recovery. At this stage, we expect negative sequential economic activity to be limited to the April to June quarter, with annual real GDP growth of 9.3% in the fiscal year ending March 2022 and 7.9% the following fiscal year. Longer-term risks to India’s economy would increase if the second wave is prolonged beyond June and the pace of vaccinations is slow. This could result in scarring to the economy through permanent job losses and destruction of businesses. Somewhat slower growth due to the second wave and higher fiscal deficits will result in a higher debt burden.

We expect the renewed surge of the virus to contribute to a marginal shortfall in revenue and a redirection of spending toward healthcare and virus response relative to what had been budgeted by the government in February 2021. As a result, we now expect a wider general government fiscal deficit of about 11.8% of GDP in fiscal 2021, compared to our previous forecast of 10.8% and an estimated 14% in the fiscal year that ended in March 2021.

We expect the general government debt burden to reach around 90% of GDP in 2021 from 72% in 2019, significantly higher than the forecasted Baa-rated peer median of about 64% in 2021. Over the medium term, prospects for the debt burden to decline have diminished and will be significantly dependent on trends in nominal GDP growth. Under average nominal GDP growth of around 11.5%, which we project as the baseline for the four years through the fiscal year ending March 2025, we expect debt to stabilize at around 92% of GDP. Meanwhile, we expect debt affordability to remain relatively weak with interest payments reaching about 28% of general government revenue in 2021, the highest among Baa-rated peers and more than three times the Baa median forecast of around 8%.

What will be the impact of such a high debt burden on Indian government finances and the sovereign rating?

India’s key credit challenges include a persistent slowdown in growth, weak government finances and financial sector risks. These vulnerabilities weighed on the sovereign credit profile prior to the coronavirus pandemic and were subsequently exacerbated by the shock. In June 2020, we downgraded India’s sovereign rating to Baa3 from Baa2, due to a weakening in the credit profile from these vulnerabilities, and maintained a negative outlook to reflect downside risks from potentially deeper stresses in the economy and financial system that could lead to a more severe and prolonged erosion in fiscal strength. Further evidence that self-reinforcing economic and financial risks are rising would put downward pressure on the rating.

As noted above, India’s weak fiscal position is its biggest credit challenge. Should downside risks to growth or the financial system materialize, negative consequences for India’s fiscal strength would follow. The longer the period of relatively subdued growth, the more likely that India’s debt burden will continue to rise. And the crystallization of further contingent liabilities for the government, in the event of renewed financial support to financial institutions, would only add to the debt burden.

When do you see the general government debt ratio coming down to the pre-pandemic (2019-20) level?

As noted above, we expect the general government debt burden to reach around 90% of GDP in 2021 from 72% in 2019. We do not expect the debt burden to decline to pre-pandemic levels in the foreseeable future. Over the medium term, prospects for the debt burden to decline have diminished and will be significantly dependent on trends in nominal GDP growth. Under average nominal GDP growth of around 11.5%, which we project as the baseline for the four years through the fiscal year ending March 2025, we expect debt to stabilize at around 92% of GDP. India’s large pool of domestic private savings, available to finance government debt, mitigates some fiscal risks posed by high government debt and weak debt affordability.

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