Rating upgrade shows reforms paying off, says S&P's Yee Farn Phua

S&P upgrades India's sovereign rating citing strong growth, fiscal discipline, and infrastructure push, while warning against policy reversals and subsidy-heavy spending

After S&P upgraded India’s sovereign rating, Yee Farn Phua, director of sovereign and international public finance ratings for Asia at S&P Global Ratings, explained to Asit Ranjan Mishra over a Zoom call the rationale behind the rating action. Edited excerpts:

 

What has changed fundamentally since your last review of India that led to the sovereign rating upgrade?

 

As you know, we changed the outlook for India to positive last year, largely because we saw a demonstrated drive towards fiscal consolidation. We also believe that gross domestic product (GDP) growth is very healthy, which has supported fiscal metrics. We also took into account the fact that the government is increasingly putting money into infrastructure spending, helping to further grow the economy down the road.

 

This improving quality of government spending, we believe, bodes well for the future economic trajectory. These factors continue to play out. This year, we are continuing to see the government demonstrate its political commitment to cut deficit. As you can see, the central deficit has been declining quite quickly. At the same time, GDP growth continues to be strong.

 

Also, this time around, we took into account the fact that the monetary policy environment is a lot more conducive in India these days. In the past three to four years, inflation has come down significantly compared to a decade ago. I think that bears testament to the Reserve Bank of India’s monetary policy framework, which we believe has borne fruit. That’s why we think all these factors are coming together now to create a positive trajectory for India’s credit metrics.

 

Some of the fundamental constraints for India’s sovereign rating, as pointed out by various rating agencies including S&P, are low per capita income, a high debt-to-GDP ratio, and high interest payments. Has the outlook changed on these fundamental parameters?

 

Yes, you’re absolutely right. All these factors are still there. They are still perhaps weaker parts of the rating construct. Not so much the low per capita GDP, because on that front we actually applied an above-average growth adjustment to India’s economic scoring. Instead of assessing India as a low-income country, the way we assess India is actually in the $15,000 per capita bracket. So we do give the benefit of the doubt on the economic front.

 

On the fiscal front, you’re absolutely right. In our parameters and metrics, India’s fiscal numbers still score in the weaker part of our criteria. But we take into account the fact that the debt profile is very favourable for India in the sense that there is no foreign currency debt for the government. Fiscal deficits, even though they are wide, have not escalated the debt burden because of strong GDP growth.

 

In fact, if you look at debt-to-GDP, it has slowly declined because of fast growth. Interest payments to revenue, as you mentioned — yes, they are a big burden for the government. About 24-25 per cent of the government's revenues go towards interest payments. That is obviously a big burden and one of the major components of the rating construct as well.

 

The Indian government has been complaining that the sovereign rating assigned to it by various rating agencies is below what India rightfully deserves. Should this rating upgrade be seen as an attempt towards normalisation, or is it because of fundamental changes in the economy?

 

Of course, it recognises the fact that there are fundamental improvements on the ground. At the same time, if you look at India as an economy, it has gone through many cycles, up and down, but at no point was it in a distress situation because of the size of the economy and its sound fundamentals.

 

The government has been implementing reforms and has been steady about the country’s credit metrics. So, if you look at it this way, the upgrade is also a recognition that these reforms have paid off and are continuing to pay off. The high growth you are witnessing, the infrastructure investments — all these point to the fact that they have helped improve credit metrics. 

 

S&P says that the US tariff impact on India will be manageable, but the tariff at present is already 50 per cent and the US is threatening to further increase it. How confident are you that the tariff threat will be manageable for India?

 

To be honest, the tariff story is still a very fast-moving one. It is very hard to give an exact impact assessment at the moment. Whether the tariff comes down eventually, we don’t know. But the reason we still went ahead with the upgrade is because we believe India’s fundamentals and growth story are strong enough to withstand these headwinds from tariffs.

 

To begin with, India is not a very trade-reliant economy. If you look at the exposure of exports to GDP, it’s about 18 per cent. Yes, the US is the largest trading partner of India, but in terms of actual exports to GDP, it’s about 2 per cent. Once you factor in the sectoral exemptions on pharmaceuticals and consumer electronics, exposure to the US is only about 1 per cent.

 

So, if tariffs are going to hit that 1 per cent of GDP, it might have an impact, but it will largely be a one-off in the near term. Over the longer term, we don’t think it will derail India’s growth prospects.

 

What other reforms should the government undertake now to maintain this sovereign rating and then aim for a higher rating? 

Of course, we can’t advise the government on what to do. But seeing what the government has been doing and pushing ahead with, these are encouraging signs to us. There is a very clear path to cut deficit and, importantly, improve the quality of government spending.

 

In the Budget, we have increasingly seen the government shift more resources away from subsidies and put them into infrastructure investment. These are all promising signs. The goods and services tax reform was also important a few years ago, and now the government is able to collect more revenue because of it and widen its tax net. All these are reforms the government is looking to push through to reform the economy.

 

What are the potential threats that could force you to downgrade India again?

 

If you look at our outlook statements, we’ve spelt it out very clearly. If the government were to turn back from fiscal consolidation and start spending more, increasing the deficit very quickly — that would be a concern. Of course, if it’s a one-off increase for one or two years because of a crisis and there’s a need to support the economy, we take a structural long-term view of such situations.

 

But if it’s clear that there is a lack of political commitment to keeping deficits down, and the government’s stance changes to spend a lot more than before, that could put downward pressure on the ratings. Another possibility is if the quality of government spending starts to deteriorate — for example, if a lot more is spent on subsidies again and the level of infrastructure investment is reduced. This could also put downward pressure on the rating.