The government also took steps to bring food inflation down. RBI’s reforms on monetary policy by moving to inflation targeting, keeping positive real rates and boosting forex reserves has increased investor confidence and boosted macro stability.
In a surprise move, Moody’s Ratings upgraded India’s sovereign bond rating from Baa3 to Baa2. The last time Moody’s upgraded India was in 2004 to Baa3, moving India to an ‘Investment Grade Destination’. Ratings below Baa3 are indicative of junk status. The last ever rating upgrade for India by any major rating agency was on January 30, 2007, when S&P had then upgraded India to BBB(-). Fitch, the other big rating firm, had upgraded India to BBB(-) in August 2006 and has not changed its rating since the last 11 years. Rating changes are very slow, infrequent and at most times move with a lag to market expectations. The government has been asking for a rating upgrade for many years now, including in 2013 when India suffered its second worst ever external account problem and was bracketed as part of the ‘Fragile Five’. The rating change is a testament to a few things which have played out since 2012-13. The first is the government’s commitment to fiscal consolidation. The fiscal deficit has been reduced from 6% of GDP in 2012 to 3.5% of GDP in 2017. The government also took steps to bring food inflation down. RBI’s reforms on monetary policy by moving to inflation targeting, keeping positive real rates and boosting forex reserves has increased investor confidence and boosted macro stability.
The Moody’s press release talks of other reforms like GST, bank recapitalisation, demonetisation and the use of Aadhaar for Direct Benefit Transfer in formalising the economy which will boost growth in the medium term. However, it cautions India’s high debt/GDP ratio which is likely to rise in the next two years on account of slower growth and also problem areas which have been fixed by bond issuances like Uday Bonds (power distribution), farm loan waivers (potentially to be funded by issuance of bonds), bank re-cap (to be funded by bank recap bonds). So the actual fiscal deficit in India is larger than it seems by the reported numbers. This is why I see the rating upgrade now as surprising. Given the evident pressures on the fiscal front and the likelihood that the government may not even meet this year’s or next year’s fiscal target, the rating upgrade seems to have come at a wrong time.
Markets should worry that the government, now having received the rating upgrade, may actually relax its commitment to reducing fiscal deficit, especially at a time when investors seem to be worrying about the same as reflected in the increase in bond yields of more than 50 basis points since August 2017. The rating change, though, should reverse the negative sentiment in the bond markets for now. Bond yields remain oversold and attractive at around the 7% mark but any large move down in bond yields will come through only on explicit clarity on the fiscal condition.
The writer is head, Fixed Income & Alternatives, Quantum Advisors