Srei Blog Moody’s Rating Upgrade

Moody’s Rating Upgrade Moody’s in a surprise move today upgraded India’s domestic and foreign currency ratings to Baa3 from Baa2 and also changed the outlook from positive to stable. The market thinks that the biggest game changer for Moody’s was the GST, NPA resolution efforts and other institutional reforms that are expected to improve productivity and tax base and enable India to achieve its high growth potential. In effect, this should also enable capping India’s debt/GDP ratio and bring it down over the longer term. The upgrade comes as a welcome relief especially for Indian asset markets – especially the bond market. However, the upgrade may not change RBI’s reaction function immediately. The basis for the upgrade:  The two factors that could have supported the ratings upgrade were the GST implementation and steps taken by the government (Insolvency and Bankruptcy Code and Recapitalisation efforts) to speedily resolve the stress being faced by the banking sector. The efficiency and productivity of the economy is expected to improve with the implementation of the GST along with the measures taken to lead to a greater formalisation of the economy (such as Demonetisation, Aadhar linking etc). Along with a widening of the tax base, efficiency in terms of utilisation of resources with efforts towards Direct Benefit transfers is also likely to help contain the government debt burden. Overall, Moody’s expects India to achieve a higher growth potential with the ongoing reforms process, despite there being some short-term risks to growth.    What Moody’s expect:  Moody’s expects GDP growth to moderate to 6.7% for FY18, as some measures like the GST and demonetisation are likely to have undermined growth in the near term. However, they expect a rebound to 7.5% in FY19 with fading drag from the recent disruptions and with improving support from the government towards the SME sector and exporters. However, one should continue to watch for private sector investment demand to pick up for this growth dynamics to be achieved. Near term risks such as higher oil prices and fiscal challenges could build some downward bias to our growth numbers, especially if the pace of NPA resolution is less than desired. India’s general government debt/GDP ratio at 68% is much worse than a median of 44% for Baa rated economies. However, Moody’s expect this to drop gradually over a longer horizon with benefits of a nominal GDP growth. Further, Moody’s believe that this high indebtedness gets mitigated by a large pool of private savings that finances government debt and takes comfort from the fact that the government has been able to elongate the maturity of debt while 90% is owned by domestic institutions and is denominated in the local currency. This effectively reduces any impact of interest rate volatility on debt servicing costs. Implications for the RBI:  Despite this upgrade the RBI would continue to remain focused on the immediate near term dynamics of global oil prices and its implications on India’s current account deficit, the fiscal deficit and inflation. Global monetary policy dynamics are changing and RBI would prefer to be patient to factor in the implications of the same. Bond and currency implication:  This upgrade was definitely not on the expectations radar and hence led to a drop of 10 bps on the 10-year G-sec yield. The upgrade served as a correction trigger for the yields being above the 7% mark but, in itself, does not lead the market’s perception of the current view of 6.80-7.10%. The dip in the currency to 64.60 was curtailed by the state run banks and oil companies. Current CAD / crude prices / fiscal deficit and the debt to GDP ratio may cause the currency to depreciate to 65.80/66.30 by end Mar’18.   The blog post is authored by Mr. K.R. Muthuraman, Sr. VP – Treasury, Srei Infrastructure Finance Limited.