Moody's rating upgrade may have just made Modi govt's job a lot harder

By Aurodeep

Credit rating agencies are a bit like strict school principals, but for governments and corporates. Countries undertake hard reforms, keep the macroeconomic climate stable, resist from overspending, and invest in good governance, so as to impress these agencies into a better rating.

There is an element of prestige involved. The previous government’s wake-up call from its reform stupor came in the form of Standard & Poor’s threatening to cut India’s credit rating to junk. That very week, Prime Minister Manmohan Singh hurriedly announced a spate of relaxation of FDI restrictions, including that of multi-brand retail.

There is also a commercial aspect to these ratings. When Indian companies choose to borrow from foreign markets, the higher is the cost of their loans the lower India’s sovereign credit rating is. After all, most companies will be judged at least as risky as the country they belong to.

In the last decade, loose monetary policy and near-zero policy interest rates by central banks of developed countries have encouraged Indian companies to increasingly seek raising finances offshore. The cost of servicing these loans increases sharply if the rupee suddenly depreciates, or the country’s credit rating suffers.

On Friday, major global credit rating agency Moody’s announced that India’s sovereign credit rating is to be upgraded from a notch above junk (Baa3) to a level up to Baa2. To quote Donald Trump, this is huge!

There are broadly two components of a credit rating: the actual rating, and the ‘outlook’, i.e., stable, positive or negative. The former generally takes a longer time to change, while the latter is more sensitive to economic developments. For instance, the current government managed to convince Moody’s and the others to change their outlook from ‘stable’ to ‘positive’ within a couple of years of its term. But cumulatively, it took India as long as 13 years for a rating upgrade.

No Longer Moody’s Blues
Rating agencies have been hard reality show judges to please. It is of little wonder that Prime Minister Narendra Modi and finance minister Arun Jaitley have been quick to reach to their Twitter accounts to acknowledge this feat. For the last couple of years, there have been numerous news reports of senior officials from GoI negotiating hard with these agencies to acknowledge their reforms. Former economic secretary Shaktikanta Das had once said in exasperation that one can’t “wait till infinity” for the rating upgrade to happen.

Chief economic adviser Arvind Subramanian complained of this in the first chapter of his Economic Survey last year — comparing India with China, which was upgraded from A+ to AA– despite its indebtedness rising from 142% to over 200% of GDP between 2009 and 2015.

There are three key aspects of Moody’s appraisal that stand out. First is the focus on productivity and formalisation of the economy: logging in the impact of GST, rationalisation of government spending and better targeting of subsidies through Aadhaar.

Second is the curious timing of the ratings’ upgrade pretty much on cue with the government’s announcement of the massive Rs 1.35 trillion recapitalisation package for the banking sector to deal with the non-performing assets (NPAs) problem.

Clearly, the government’s previous package of Rs 700 billion under the Indradhanush programme was too inadequate to make an impression. The importance of arming public sector banks (PSBs) with capital is a key route to undertaking angioplasty of the choked investment pipeline; and a key impediment to falling growth.

But the third curious aspect of the Moody’s assessment is the focus it has put on improving fiscal rectitude. On the one hand, it is true that this government has been fiscally responsible and resisted the urge to indulge in expensive populism. It also seems to be in broad agreement with the Fiscal Responsibility and Budget Management (FRBM) Review Committee report that will potentially bind it to ambitious cuts in fiscal deficit. It is, however, curious because recent fiscal trends would suggest a strong possibility of GoI violating its fiscal deficit target of 3.2% of GDP.

It’s an Upgreat!
Second, the creation of Rs 1.3 trillion of government paper will eventually mean an escalation of interest payments, which already amount to 90% of the Centre’s fiscal deficit. With India’s debt-to-GDP ratio one of the highest among emerging markets, there should be little appetite for cleverly disguised off-balance sheet borrowing. Moody’s seems to inadvertently opine that the fiscal implication of the bank recapitalisation package is a justified trade-off.

Getting a rating upgrade is impressive. But given the importance that the assessment places on fiscal improvement, Moody’s indirect warning to the government is to refrain from having a populist Budget next year, and stay away from the temptation of undoing its fiscal consolidation in an effort to boost growth. To quote one of the early Spiderman movies: with great power comes great responsibility.