What more can India do to win over the Big Three sovereign rating agencies?

A high sovereign credit rating can raise a country's star among the global investor community; a low rating, indicating doubts over ability to repay debts, increases its financing costs

The G20 summit over the weekend made news for those who came and a bit for those who did not. However, the two leaders who made news for not coming — Russia’s Vladimir Putin and China’s Xi Jinping — were present at the Brics summit in Goa in October 2016.

That was when the five-nation grouping explored setting up an independent credit rating agency. It was an attempt to break out of the global sovereign rating market controlled by the Big Three — S&P, Fitch, and Moody’s — all based in the United States.

Brics, short for Brazil, Russia, India, China, and South Africa, had already set up the New Deve­lopment Bank to meet the members’ funding requirement and said it would welcome “experts exploring the possibility of setting up an independent Brics rating agency based on market principles....”India was seen to be a prime mover behind this.

Although the Brics rating agency never came to be, over questions about the credibility it could muster, India’s sentiment towards global rating agencies has remained consistent.

In the 1990s and mid-2000s, India’s sovereign credit rating was “speculative grade". It was upgraded to “investment grade” by Moody’s in 2004, Fitch in 2006, and S&P in 2007.

For several years at the beginning of this century, the Indian economy grew at an average rate of more than 6 per cent, and at approximately 8 per cent in some of those years. However, India’s high rate of economic growth co-existed with the unflattering credit rating.

“Never in the history of sovereign credit ratings has the fifth-largest economy in the world been rated as the lowest rung of the investment grade (BBB-/Baa3),” India’s Economic Survey for 2020-21 asserted in a chapter titled, “Does India’s Sovereign Credit Rating reflect its fundamentals? No!”

India is now widely described as the “fastest-growing major economy”. In May, the International Monetary Fund described the country as a “bright spot” in the world economy. India’s gross domestic product (GDP) grew at its fastest pace in four quarters — 7.8 per cent — in the April-June period of FY24, aided by a supportive base along with a robust increase in investment. What is more, the G20 summit reaffirmed the high global stature the country has come to acquire.

However, it is not clear how convinced the sovereign credit rating agencies are. Starting May this year, all the three — Fitch, S&P, and Moody’s — have reviewed their sovereign credit ratings for India and kept them unchanged at the lowest investment grade, just above “junk” status.

A country’s sovereign credit rating indicates its ability to repay its debt. Investors use these ratings while assessing the risk profiles of countries. A low rating, indicating doubts over the country’s ability to repay its debt, increases its financing costs.

So, what is up with India’s ratings?

Explaining this to Business Standard, Jeremy Zook, director, Asia Sovereign Ratings at Fitch Ratings, says country ratings are based on a “relative assessment” of creditworthiness of all the sovereigns Fitch rates, using both quantitative and qualitative assessment of structural, economic, fiscal and external drivers of creditworthiness.

“Our sovereign rating for India reflects our views on its relative credit-related strengths and weaknesses compared to peer countries. India’s current rating level is supported by its strong economic performance, which we expect to be sustained over the medium term. Public finances, however, remain the key weakness for the India sovereign relative to its peers,” he adds.

For Moody’s, India’s debt situation is one of the focus areas, especially during this time of higher interest rates.

“At the current rating of Baa3, we are looking at a larger stock of debt along with associated challenges, especially with regard to what we call debt affordability. In the global and domestic environment, where interest rates are going to stay higher than they were in the past, the debt affordability challenge is going to be much more important considering the large stock of debt. We acknowledge the strengths, but we also acknowledge the weaknesses,” says Christian de Guzman, senior vice-president at Moody’s Investors Service, in a conversation with Business Standard.
 

Fitch’s Zook says India’s sustained high fiscal deficits have contributed to an elevated debt-to-GDP ratio of around 84 per cent, compared to the ‘BBB’ median of 55 per cent. “Further, India has an interest payment to revenue ratio of around 27 per cent, which is well above any other ‘BBB’ sovereigns where the median ratio is 5 per cent,” he says.

By comparison, says S&P, Indonesia, which is considered to be a peer of India, has a debt to GDP ratio of 40.1 and interest payment to revenue ratio at 13 per cent. S&P rewards Indonesia with 

a BBB rating, one notch higher than India’s.

But India’s contention has been that its debt to GDP ratio is mostly domestically held, with little risk of an external debt default that one has seen in countries such as Argentina, Zambia, or Sri Lanka. But Moody’s remains unconvinced.

“When you look at our methodology, there are many indicators that we look at — GDP, the stock of debt, debt affordability, the structure of debt, GDP per capita, the strength of the banking system, the amount of foreign exchange reserves, there are many indicators. The foreign currency share of debt is only one indicator, and it will not be a big determinant of a rating. There are countries that have opted to default on local currency domestic debt while being current on foreign currency external debt, like Jamaica in 2010 or Russia in 1998,” says Guzman.

For India to bring down its debt to GDP ratio, it has to continue slashing its fiscal deficit while expecting that the nominal GDP continues to expand at a faster pace.

The only solace — if it can be called that — is that India is not alone in its struggle with rating agencies. At the beginning of last month, Fitch downgraded the United States government’s credit rating, saying it had noted a "steady deterioration" in governance over the last 20 years and was concerned about an expected fiscal deterioration over 

the next few.

This led the US government to criticise the downgrade.

In India's case, the country’s relatively low per capita income does not help. But Guzman says per capita income does play a role in the assessment of economic strengths.

“Our use of this measure on a PPP (purchasing power parity) adjusted basis is supportive for India as non-tradables here are cheaper than elsewhere. For economic strength, we are also strongly incorporating the size of the economy at the highest possible score,” he says.

As of 2022, India’s GDP per capita stood at $2,400, whereas Indonesia boasted twice that, with a GDP per capita of $4,800.

“Even if the GDP suddenly were to double tomorrow, this score will not change as it is alre­ady at the highest level. What will move the needle are things like GDP per capita, which is consi­stently improving over time,” Guzman adds.

This would mean that even if the government succeeds in making India the third-largest economy in the next five years, it might make no material difference to the country’s sovereign credit rating. What could possibly help is reprioritising the priorities.