Rating upgrade in 2 yrs if reform pace sustains: Marie Diron

Interview with Senior vice-president for sovereign risk, Moody's Investors Service

A day before Moody's Investors Service representatives are to meet finance ministry officials, the rating agency's senior vice-president for sovereign risk group Marie Diron tells Ishan Bakshi a rating upgrade could happen in a couple of years depending on the progress on reforms. Moody's has assigned India the lowest investment grade with a positive outlook. Edited excerpts:

Finance ministry officials are likely to press for a rating upgrade, given the improvement in the macroeconomic environment. What are your views on India’s position?

We are meeting finance ministry officials tomorrow (Wednesday). It is part of our annual visit to India. Pressure is building up for a rating upgrade. It could happen in a couple of years, provided reform momentum continues and there is effective implementation. These meetings are to help us form an assessment of the policy measures undertaken by the government.

What are the specific steps that the government needs to take for a rating upgrade?

We are not focused on specific measures. We look at measures in terms of their credit implications, their implications on growth, fiscal performance and potential external vulnerability. In that respect, this positive outlook is framed within the idea that India is moving towards a stable macroeconomic environment — moderate inflation, robust growth, lower current account deficit and a lower fiscal deficit. That’s how we look at these policy measures.

Is India in a better position than two years ago? Is there a stronger case for a rating upgrade now?

There has been some improvement compared to two years ago, particularly on the external side, with the current account deficit narrowing. So given the vulnerability with regard to the US Federal Reserve raising interest rates and the volatility in financial markets, India is now in a better position to face these shocks. But what is less positive is investment, which has been weak despite relatively better gross domestic product (GDP) growth.

In your presentation you listed India’s debt level as a risk. But wouldn’t higher nominal GDP growth bring down the debt-to-GDP ratio?

A higher nominal GDP growth would be a positive as it would mean that revenue generation is higher than it is currently. The question is where would that come from? At the moment, we think the constraint for nominal GDP growth is pricing power for corporate. That goes back to the relatively muted demand environment at home and abroad as well as the debt burden for some firms.

You said the low revenue-to-GDP ratio is a constraint for the government. But wouldn’t the implementation of the GST actually help raise the tax revenue-to-GDP ratio?

That is likely to help over the medium term. It will take a few years before that materialises as GST is initially revenue-neutral. For a revenue-positive impact to come through, the informal sector has to transit into the formal sector. You also need to see lower costs for government in terms of administrating this as well as lower costs for corporate. So that is a medium-term horizon.

What is your view on the health of the banking sector?

We think that in terms of bad asset recognition, the bulk of it has happened. There’s probably more to go but much less than what we’ve seen in the last years. So the first step coming to an end. The next step is the resolution of these bad assets, and there we don’t think it will proceed quickly.

Why are you sceptical on that front?

So far there is no great detail of how this will happen. There are costs involved for the banks as well as the government and it isn’t quite clear that the space is there to absorb them. The medium-term concern is how to prevent a reoccurrence of these bad assets. That involves governance reforms, risk management.

What do you think will kick-start the private investment cycle in India?

There are various factors at work here. First, the constraint is partly because investment-intensive sectors such as infrastructure, utilities, transport are also sectors where corporate debt is very high. So companies in these sectors are financially constrained to invest. This will take a while to overcome. Second, companies in other sectors might not readily have access to external sources of finance such as bond markets or banks. Third, for companies to invest, they need certain infrastructure around them. Public sector investment in infrastructure could in those cases have a positive impact on private sector investments.

Is the revival constrained by weak global demand and excess capacity in sectors such as steel?

In sectors such as steel, where there is global overcapacity, we do not think it will change materially over the next few years. So investment in these sectors is likely to be weak. If there is some investment, it is likely to be accompanied by lower profitability because the pressure on prices is very strong. There are other sectors such as services sector which is strong in India and that is where companies need more investment in skills. It’s a different kind of infrastructure.

Can the government boost public investment to crowd-in private sector investments?

There are limitations on the fiscal front. But there’s also reshuffling of spending on the government side. If greater emphasis on public investment is sustained, it can be a positive but at the margin, the room for the government to ramp up investments significantly is limited.