Why Moody’s upgraded India’s bond rating and how they prove some experts wrong

Indians woke up to good news today. International rating agency Moody’s Investors Service upgraded the Government of India’s local and foreign currency issuer ratings to Baa2 from Baa3 and changed the outlook on the rating to stable from positive. Moody’s also upgraded India’s local currency senior unsecured rating to Baa2 from Baa3 and its short-term local currency rating to P-2 from P-3. This also happens to be the first such upgrade, since 2004:

While the conspiracy theories are not out yet, do not rule out some “neutral experts” dishing out various reasons such as “Moody’s is paid”, or “its easy to fix ratings”. Some will also question the timing of the upgrade, since it precedes Gujarat elections, thus raising doubts on the ratings themselves. Some may even question the methodology.

But the real reasons for the upgrade are very clearly, enshrined in Moody’s own press release. Moody’s lauds the ” continued progress on economic and institutional reforms”, which they believe “enhance India’s high growth potential”.

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Moody’s then goes into specifics and specifies certain measures which helped them upgrade the ratings (emphasis added):

Key elements of the reform program include the recently-introduced Goods and Services Tax (GST) which will, among other things, promote productivity by removing barriers to interstate trade; improvements to the monetary policy framework; measures to address the overhang of non-performing loans (NPLs) in the banking system; and measures such as demonetization, the Aadhaar system of biometric accounts and targeted delivery of benefits through the Direct Benefit Transfer (DBT) system intended to reduce informality in the economy. Other important measures which have yet to reach fruition include planned land and labor market reforms, which rely to a great extent on cooperation with and between the States.

GST, Action on NPAs, Demonetisation, Aadhaar linking and DBT, these are some of the issues which Moody’s believes are “key elements” of India’s “reform program” which enabled the ratings upgrade. The Indian opposition, and also some “neutral experts” have been targeting the Indian Government exactly on these issues, saying these steps were actually huge mistakes!

Mood’s also believes the above measures will help in formalizing India’s economy and in turn improve India’s fiscal metrics:

….measures which increase the degree of formality in the economy, broaden the tax base (as with the GST), and promote expenditure efficiency through rationalization of government schemes and better-targeted delivery (as with the DBT system) will support the expected, though very gradual, improvement in India’s fiscal metrics over time. 

Nevertheless, Moody’s accepts that the above steps have undermined growth in the near term, but emphasizes that India’s growth potential in the longer term is still intact, and in fact “significantly higher” than other countries in the same ratings level.

Most of these measures will take time for their impact to be seen, and some, such as the GST and demonetization, have undermined growth over the near term. Moody’s expects real GDP growth to moderate to 6.7% in the fiscal year ending in March 2018 (FY2017). However, as disruption fades, assisted by recent government measures to support SMEs and exporters with GST compliance, real GDP growth will rise to 7.5% in FY2018, with similarly robust levels of growth from FY2019 onward. Longer term, India’s growth potential is significantly higher than most other Baa-rated sovereigns.

Moody’s also lauds the efforts of the Government for strengthening various institutions and increasing their transparency. It also acknowledges that inflation has declined markedly (contrary to what Congress just claimed falsely), and forex reserves have peaked:

Government efforts to reduce corruption, formalize economic activity and improve tax collection and administration, including through demonetization and GST, both illustrate and should contribute to the further strengthening of India’s institutions. On the fiscal front, efforts to improve transparency and accountability, including through adoption of a new Fiscal Responsibility and Budget Management (FRBM) Act, are expected to enhance India’s fiscal policy framework and strengthen policy credibility.

Adoption of a flexible inflation targeting regime and the formation of a Monetary Policy Committee (MPC) have already enhanced the transparency and efficiency of monetary policy in India. Inflation has declined markedly and foreign exchange reserves have increased to all-time highs, creating significant policy buffers to absorb potential shocks.

The recent plan of bank recapitalization also earned plaudits, again another step which was vilified by some “neutral experts”:

Recent announcements of a comprehensive recapitalization of Public Sector Banks (PSBs) and signs of proactive steps towards a resolution of high NPLs through use of the Bankruptcy and Insolvency Act 2016 are beginning to address a key weakness in India’s sovereign credit profile.

Moody’s also acknowledges that while much of the above is great, much more needs to be done:

Much remains to be done. Challenges with implementation of the GST, ongoing weakness of private sector investment, slow progress with resolution of banking sector asset quality issues, and lack of progress with land and labor reforms at the national level highlight still material government effectiveness issues.

However, Moody’s remains optimistic that over time these issues, would be resolved:

However, Moody’s expects that over time at least some of these issues will be addressed, resulting in a steady further improvement in India’s government effectiveness and overall institutional framework.

Moody’s has said what it wants to say. Now its up to the media persons to don their “economy expert” hats and pontificate on subjects they have no knowledge of.


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