Ratings and reforms

Fiscal position should be improved with sustained growth

In a recent interview, a senior executive of one of the big global rating agencies said the inclusion of Indian-government bonds in global bond indices would not considerably increase the government’s strength to fund itself, and improving debt affordability will be a crucial criterion for an upgrade. There is considerable enthusiasm — both in the government and financial markets — about India’s inclusion in global bond indices. JPMorgan has announced it will include Indian bonds in the emerging market bond index from June this year. The inclusion, according to market estimates, is expected to bring in stable foreign flows of $25 billion. Bloomberg Index Services has also announced it will include Indian bonds in the emerging markets index from January. Meanwhile, FTSE Russell has kept India on the watchlist. Although the scale may not make a material difference at this stage, tapping foreign savings to finance the fiscal deficit will technically ease the pressure on domestic sources over time as more bonds are issued under the so-called fully accessible route. What will help improve credit ratings is the implementation of structural reforms and strong growth momentum, which will help improve the fiscal position. India must focus on these aspects anyway.

There has been a considerable debate in India on how rating agencies view it. These agencies have assigned the lowest investment-grade ratings to India, even though the country has never defaulted on its debt obligations. A collection of essays, released by the Office of Chief Economic Adviser in the Ministry of Finance, in December 2023 highlighted issues related to the methodology adopted by rating agencies and noted: “Our review of the credit rating methodologies reveals that there is considerable reliance on qualitative variables to capture ‘willingness to pay’.” Dependence on qualitative variables often raises questions about rating actions. For instance, as the essay highlighted, between 2020 and 2022, over 56 per cent of the countries in Africa rated by one of the three big rating agencies were downgraded. In Europe, on the other hand, it was only 9 per cent.

Rating agencies have often remained behind the curve. This was clearly witnessed during the global financial crisis and later through the European debt crisis. However, irrespective of the debate on methodology and their performance, credit ratings are extremely important in financial markets. A better rating lowers the cost of debt finance. Money managers are often mandated to hold papers of companies or sovereigns above a certain level of credit rating. However, given the size and complexity of the Indian economy, delays in potential rating upgrades should not hold it back. India has been growing at 7 per cent plus in the post-pandemic period and policy interventions should be focused on sustaining the momentum.

However, it is worth noting that economic growth has been significantly driven by the government’s capital expenditure, which has led to slower fiscal consolidation after the pandemic. From the perspective of credit ratings and the cost of borrowing, in general, it is important to reduce the general government budget deficit and public debt to more manageable levels, with minimal impact on growth. The Indian economy will have to find growth drivers beyond government capital expenditure. It will thus be crucial for the next government to push forward structural reforms, which will increase business confidence and help revive private-sector investment to sustain economic growth. Rating upgrades will follow a strong fiscal position supported by sustainable growth.