Calling the reform process slow and gradual with muted private investment and NPAs posing a challenge, Moody’s today said it could upgrade India’s rating in 1-2 years if it is convinced that reforms are “tangible”.
Moody’s, which has a ‘Baa3’ rating with a positive outlook, said evidence of policymakers working towards a faster fiscal consolidation, reducing the debt-GDP ratio and addressing infrastructure and monsoon volatility challenges will determine an upgrade, going forward.
“We have a positive outlook on India. On balance, the risk is on the upside. We are continuously monitoring the rating. We see pressure building up in 1-2 years and any tangible change could bring about a change in rating,” Moody’s Sovereign Group Senior V-P Marie Diron told reporters.
Moody’s listed six agenda on the list of pending reforms — land acquisition Bill, labour law reforms, significant infrastructure investment, tangible benefit from Make in India initiative, tax administration and PSU bank reforms.
Stressing that weak financial health of PSU banks continues to pose contingent liability risk and muted private sector investment constrains India’s ratings, Diron said external sector vulnerability and geo-political risks could pose additional pressure.
Moody’s Investors Service had in April 2015 revised India’s outlook to positive from stable and said it could upgrade rating in 12-18 months.
Asked if policies are moving in the direction as envisaged by Moody’s for an upgrade, Diron said: “We have seen progress in implementation of reforms. What we did not anticipate is the weakness of private investment.”
Diron added: “Reforms have been slow and gradual and we are waiting for that confidence that reforms will be tangible and able to change investor confidence, and corporates start seeing improvement in business environment.”
Terming passage of GST and the bankruptcy law, the move towards the fiscal deficit range and inflation-targeting monetary policy as “credit positive”, Diron said increased policy transparency and credibility display institutional strength in the economy even as corruption still persists in some sectors.
Speaking at a joint Moody’s-Icra sovereign and macro- economy briefing here, Icra Senior Economist Aditi Nayar said economic growth will pick up in 2016-17 to 7.9 per cent, from 7.6 per cent last fiscal.
Nayar said retail inflation will be in the 4-5 per cent range till November as food prices decline and will continue to rise from December to touch 5.2 per cent in March-end.
“We expect 0.25 per cent cut in repo rate in the policy review in December. Once the monetary policy committee is set up, future rate cuts would depend up on the timeframe that they adopt to reach the median point of the 2-6 per cent inflation target,” she said.
Nayar further said the GST rate will be crucial for determining future rate cuts as it will have its bearing on inflation and growth.
Meanwhile, finance ministry officials would pitch for a rating upgrade with Moody’s at its meeting tomorrow. As for the banking sector, Diron said while bad asset recognition is a first step, this does not strengthen resilience of banks and therefore does not reduce contingent liability risks for the sovereign.
Moody’s estimated that fiscal costs of equity injection in public sector banks are manageable although they are larger than currently budgeted and will add to the government’s challenge in meeting its fiscal targets.
“Banks are characterised by weak profitability and low capitalisation. Risks for sovereign will be mitigated when bad assets get reduced and that will take time,” Diron said.
Moody’s also said in the near term, challenging Budget targets could lead to significant spending cuts late in the year, especially since fiscal deficit till July had touched 74 per cent of the whole year’s target.
“The credit implications of India’s reforms will materialise in the medium term,” it said.
In the near term, Moody’s expects that private investment will remain weak as corporates in investment-intensive sectors are burdened by elevated debt levels.
In addition, the economy will remain vulnerable to fluctuations in monsoon rains. In general, infrastructure gaps will continue to constrain investment and the rise in FDI will not make up for muted domestic investment, it cautioned.
In terms of the monetary policy framework, the government has notified a CPI inflation target of 4 per cent, within a tolerance band of 2-6 per cent until March 2021.
“Such a scenario would help anchor inflationary expectations. In addition, a favourable base effect as well as improved crop sowing dynamics will ensure CPI inflation remains within this tolerance band in the near term,” Icra said.
Nayar said growth would be consumption led driven by increased spending, post Pay Commission award, and there is unlikely to be much pick-up in investment.
“With stretched balance sheets, we do not expect broad-based pick-up in investment activity,” Nayar said.
Moody’s further said a few fiscal measures entail some, although limited, immediate savings for the government, including through subsidy reform and more moderate increases in minimum support price (MSP) than in the past.
“The implementation of the goods and services tax (GST) — which Moody’s assumes will become effective 2017 — will enhance revenue collection for the government over time through better tax compliance and higher profits as businesses save on tax administration costs,” it said.
Moody’s further said some reform measures, if effectively implemented, will bolster India’s growth potential.
According to the agency, easing of restrictions on FDI could foster productivity growth in some sectors, the bankruptcy law, if credible, will enhance investor confidence, besides measures like improved access to bank accounts and those aimed at easing business starts.
‘Baa3’ is the lowest investment grade — just a notch above junk status.