Change in mood

Govt deserves credit, must stay the reforms course

In what is unquestionably good news for the Indian economy, international credit rating agency Moody’s has raised India’s sovereign bond rating from Baa3 to Baa2. The upgrade means that it should be easier not just for the sovereign but also for large public sector firms and some private sector companies, particularly blue chips, to access foreign funds. In raising India’s sovereign rating, the agency said that it was responding to reforms that the government had implemented so far as they would improve the business climate and create the conditions for strong and sustainable growth. The government has long argued that a ratings upgrade is necessary, pointing to its commitment regarding fiscal consolidation and India’s stable macroeconomic indicators in particular. The upgrade will come as a strong signal of confidence for economic stability and serviceability of debt. The government deserves praise for pushing through the various policy changes that helped make the upgrade possible. However, it is still too premature to celebrate.

Moody’s itself has highlighted the risks to the current rating, and to India’s growth momentum in general. It has singled out two considerations: The health of the banking system, and vulnerability on the external account. The assumption is that the banking system is on the mend, now that many major delinquent accounts have been sent into the new insolvency process, banks have made suitable adjustments to their balance sheets for problematic assets, and the government has worked out a recapitalisation plan for struggling public sector banks. However, if the process does not work as advertised, then there could be a problem in terms of credit growth and financial stability. This would impact the broader economy — and, of course, the outlook on India’s new sovereign rating. As regards Moody’s mention of the fear of external vulnerability, this is not a problem at the moment — India’s sovereign has very little foreign borrowing, foreign inflows are continuing, foreign exchange reserves are comfortable, and, if anything, the currency is a little too strong.

But it is also true that much depends, as it has in the past, on the price of crude oil. If it does hit $70 a barrel, then India’s balance of trade deficit — already increasing — will be in the less stable territory, with follow-through effects on other indices of external vulnerability. The government should always keep this danger in mind. Also, as Moody’s has flagged, the high public debt burden remains an important constraint on India’s credit profile relative to peers. At 68 per cent of its gross domestic product in 2016, general government debt in India is significantly higher than the 44 per cent median for other similarly ranked economies, and, more to the point, higher than the 60 per cent that has been recommended by the N K Singh committee as desirable. And therein lies the challenge.

Overall, the government is right to take a victory lap: Its efforts have been rewarded by international recognition. This comes after the World Bank raised India’s place in the Doing Business rankings by 30 notches to 100. Together, it suggests that the India macroeconomic story is doing better than it had for some time. Yet, for the economy to capitalise on this upgrade, the political leadership must stay the reforms course and resist the temptation to resort to populism.