Ratings firm Moody’s Investor Service on Thursday raised India’s credit rating outlook to positive signaling a global acceptance of the reforms initiatives of the new government and also indicating a push up for market sentiments that have been faltering in the past few sessions.
In a statement issued early Thursday, Moody’s said India’s Baa3 rating has been affirmed and the outlook on the credit profile revised upward from stable. “India has grown faster than similarly rated peers due to favorable demographics, economic diversity and high savings and investment rates. There is an increasing probability that actions by policy makers will enhance the country’s economic strength and in turn, the sovereign’s financial strength over the coming years,” the Moody’s statement said. Evidence over the coming months that policymakers are likely to be successful in their efforts to introduce growth-enhancing and growth-stabilizing economic and institutional reforms would lead to the rating being considered for an upgrade, it said.
The benchmark BSE Sensex rose over 167 points in early trade on Thursday after Moody's upgraded rating outlook. The 30-share index, which had gained 750.26 points in past four sessions, rose further by 167.33 points, or 0.58%, at 28,875.08 with all sectoral indices, led by metals and IT, rising up to 0.92%.
India is in the lowest investment grade rubbing shoulders with countries like Indonesia, Turkey and Iceland. A Baa3 rating signifies the risk that higher levels of growth and infrastructure development will be accompanied by higher leverage.
Ratings outlook for countries assign grades to the sovereign’s ability to borrow and can add to the cost of loans in the international markets. A higher rating lowers the cost of borrowing indicating increased ability of the borrower to service the loan.
The Moody’s outlook upgrade comes days after the Reserve Bank of India left key interest rates unchanged in a dovish assessment of the Indian economy while waiting to see the impact of unseasonal rains on inflation before extending its monetary stance. The central bank had already cut rates twice in the past three months on the back of an improved economic outlook.
Rationale for the positive outlook
Moody's decision to revise the ratings outlook to positive from stable is based on its view that there is an increasing probability that actions by policy makers will enhance the country's economic strength and, in turn, the sovereign's financial strength over coming years.
India has grown faster than similarly rated peers over the last decade due to favourable demographics, economic diversity, as well as high savings and investment rates.
Moody's expects these structural advantages, supported by relatively benign global commodity prices and liquidity conditions, will keep India's growth higher than that of its peers over the rating horizon.
However, recurrent inflationary pressures, occasional balance of payments pressures, and an uncertain regulatory environment have contributed to periods of volatility in growth, and have exposed India to external and financial shocks, constraining its credit profile.
Moody's believes that recent measures to address inflation, keep external balances in check, simplify the regulatory regime for investors, increase foreign direct investment, and facilitate infrastructure development will reduce some of India's sovereign credit constraints.
Many of these measures are at relatively early stages of design and have yet to be implemented. According to Moody's, the ability of policymakers to strengthen India's sovereign credit profile to a level consistent with a higher rating will become apparent over the next 12-18 months.
Rationale for affirming the Baa3 rating
India's Baa3 government bond rating incorporates credit strengths, such as its diversified economy, robust growth prospects, relatively high domestic savings rate and high international reserve buffers.
It also reflects India's weaker performance -- relative to peers -- on fiscal, inflation and infrastructure-related metrics. And while policies are beginning to address each of these factors, the extent of likely improvements is as yet unclear.
Moreover, India's banking system's asset quality, loan loss coverage and capital ratios are relatively weak. This poses sovereign credit risks because of the banking sector's role in financing growth as well the government's deficits through its purchase of government securities, and the contingent liabilities due to the government's ownership of a major portion of the banking sector. In the absence of any improvement in banking-system metrics over the coming months, India's sovereign credit profile will remain constrained.
The Baa3 rating incorporates the risk that higher levels of growth and infrastructure development will be accompanied by higher leverage.
Sovereign credit improvements over the next 12-18 months will depend on the extent to which growth, policies and buffers can contain the risks associated with rising leverage, Moody's said in a statement.