The Moody’s statement says, at 68% of GDP, India’s consolidated fiscal deficit is significantly higher than the Baa median of 44%, and that it expects India’s debt-to-GDP ratio to rise about one percentage point due to the slowing of nominal GDP as well as the implementation of GST.
The timing of Moody’s ratings upgrade, the first in 13 years, is ironic since it comes at a time when, while still good, India’s fundamentals don’t look as solid as they did, say, a year ago— but no rater was prepared to upgrade India at that point. And even while it is likely the government will slip on its fiscal commitments this year, Moody’s seems to have, rightly, shifted its focus from just traditional deficit- and debt-based indicators and, instead, looked at the big reforms undertaken in the last few years. Indeed, the Moody’s statement says, at 68% of GDP, India’s consolidated fiscal deficit is significantly higher than the Baa median of 44%, and that it expects India’s debt-to-GDP ratio to rise about one percentage point due to the slowing of nominal GDP as well as the implementation of GST. If the rating agency has upped its rating despite this, it is because the various reforms will, over time, change India in a fundamental manner. The Aadhaar-based direct benefit transfers will, for instance, remove the 40-50% leakages associated with India’s generous subsidy programme of around Rs 3 lakh crore every year and the GST will raise the tax-to-GDP ratio since it forces formalisation of the economy and, through its input tax credit system, creates a disincentive for dealing with firms that don’t pay taxes.
And since it was always clear that the biggest growth bottleneck was the twin balance-sheet problem—both corporate and bank balance sheets were deeply stressed—the government is trying to address this through the insolvency code and bank recapitalisation. The insolvency code is aimed at ensuring banks are able to, finally, recover part of the over Rs 8.5 lakh crore of loans stuck as NPAs—albeit after a major haircut—while the recapitalisation is aimed at restoring the big hole in the banks’ balance sheets; if the recapitalisation is not accompanied by sweeping banking reforms, including privatisation, it may turn out to be a damp squib, but the government has promised a slew of banking reforms. The recap, in fact, can help lower borrowing rates since, as the NPA burden has risen, banks have raised their spreads to finance this.
How the upgrade will play out remains to be seen, as does the question of whether S&P follows Moody’s. There will, of course, be an immediate movement in the rupee and perhaps a longer rally in the market, but beyond that, the impact is more of a mood-enhancer and will depend on further reforms in different sectors. While India’s FDI levels were booming even when the ranking was lower—FY16 FDI was $55 billion and FY17 $60 billion—allowing FDI in multi-brand retail or easing rules for food-retail could result in a big jump, as happened in the case of petroleum when natural gas prices were raised and a path to market-linking was laid out. Given the Pew survey shows prime minister Modi’s appeal has only gone up despite being in government for three years, it would suggest the government has enough scope to implement further reforms should it want to. Getting local investment levels up—gross fixed capital formation has fallen from 34.3% of GDP in FY12 to 26.9% in FY17—will require building on what reforms have already been made, especially in areas like labour and onerous government regulations.