How vulnerable is India’s sovereign rating?

Prime Minister Narendra Modi’s announcement of a ₹20 lakh crore stimulus package is timely and appropriate. The announcement goes beyond the amount and reflects the government’s intent to alter the economic narrative through substantial reforms. Its intent is to facilitate large-scale investments towards ‘Make in India’ and infrastructure, thereby generating employment opportunities. A similar tonality was expressed in the Finance Minister’s speech, too, as evident by announcements around support to MSMEs, partial guarantee to NBFCs or liquidity injections in discoms.

Sovereign raters, however, have been expressing their concerns on India’s rating (Baa2 by Moody’s with negative outlook, BBB- by Fitch), particularly in light of a large fiscal stimulus. While their concerns on India’s economic vulnerabilities may hold ground, yet rating is a relative indicator of creditworthiness, hence it is important to evaluate the country in relation to its peers’ economic situations.

Considering a basket of Indonesia, Kazakhstan, Bulgaria, Colombia, Panama and the Philippines, countries that are in BBB category, we observe that while this group averaged a growth of 4.4 per cent in CYs (calender years) 2016-19, it was 7.1 per cent for India. A well-conceived stimulus package will help India grow at 1.9 per cent, while as per the IMF, the global economy will shrink by 3 per cent. However, India’s per capita income on a PPP basis at $8,378 is significantly lower than the median in the BBB category; indicating that while a large population does give demographic dividend, it also has an adverse effect.

Fiscal deficit

India’s average federal fiscal deficit over CYs 2016-19, at 3.5 per cent, is higher than peer average of 2.6 per cent. However, over this period, the fiscal deficit declined, and its variance is the least among peers. That’s noteworthy. India has been fairly frugal despite expanding fiscal space being the only alternative to drive growth.

The trajectory of public debt is in line with the fiscal position. While India has a high public debt obligation at around 68 per cent of GDP, its debt coverage levels are somewhat mitigated by the consistency in the debt profile and the minimal proportion of foreign currency debt.

When compared to BBB- basket countries, the size of sovereign debt is 78 per cent of GDP. In the higher BBB+ basket, the debt tolerance is surprisingly higher with size of public debt averaging 82 per cent and mean fiscal deficit going up to almost 3 per cent. This is partly because some sovereigns such as Italy and Spain enjoy supranational sovereign guarantee from the EU. This provides them a flexibility to maintain public debt in excess of 100 per cent and a fiscal deficit of nearly 2.5 per cent of GDP despite sub one per cent growth.

Tax revenues

One of the key rating weaknesses for India has been its lower than average tax revenue at 17 per cent of GDP; the peer average of 18 per cent is only slightly higher. India is characterised by a largely unorganised economy, constraining its tax coverage. However, GST has been an important reform. We expect a steady increase in the tax-to-GDP ratio over the longer term as adherence and number of income taxpayers increase.

India’s peers in the BBB basket earn substantially via commodity exports. With sharply lower oil and commodity prices (big advantages for India), some of these peer nations are likely to witness severe pressure on their revenues. Though India’s tax revenues will also be under pressure, its volatility will be significantly lower.

India is expected to reach a nominal GDP milestone of $3 trillion in CY20. Competitiveness of its services sector and favourable demographics with a growing middle class will continue to drive growth.

Strong institutions

India’s institutions strengthened with milestone reforms such as GST and bankruptcy code in the last three years. Its strong central bank administers a monetary policy that maintains a balance between growth, inflation and liquidity. Foreign reserves are robust at $442 billion. Consumer inflation has moderated significantly. Further, India has a stable federal government with policies that encourage foreign and private sector investments. We expect the economy will start recovering as soon as the impact of the lockdown fades away.

While the improvement in per capita income will require robust economic reforms and a consistent high growth trajectory, we expect the economy to revert to its regular growth path and fiscal prudence by FY22. A medium term disruption in the growth as well as the fiscal trajectory is foreseeable but will need to be looked at on relative basis vis-à-vis peers who are more vulnerable.

The global rating agencies should not only take cognisance of the above aspects but also India’s resilience through past economic crises since the 1990s, its adequate foreign currency reserves and its strong democratic, institutional and regulatory framework.

The writer is CEO, Acuité Ratings and Research