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Informist, Thursday, Aug 22, 2024

 

--Moody's de Guzman: India must slash interest cost for rtg upgrade

--Moody's de Guzman: India must cut debt-GDP ratio for rtg upgrade

--Moody's de Guzman: Will raise India FY25 growth forecast by Aug-end

--CONTEXT: Comments by Moody's Ratings Christian de Guzman in interview

--Moody's de Guzman: External situation biggest risk to India growth

--Moody's de Guzman: India coalition govt could slow down reforms

--Moody's de Guzman: India's FY26 fisc gap aim of 4.5% looks credible

--Moody's de Guzman: Don't see rapid India fisc consolidation post FY26

--Moody's de Guzman: Don't expect to see 3% India fisc gap anytime soon

--Moody's de Guzman: India fisc consolidation to be gradual, positive

--Moody's de Guzman: Look at debt burden, not fiscal deficit for rtg

--Moody's de Guzman: India debt burden is 3rd-highest among Baa peers 

--Moody's de Guzman: India's debt-GDP ratio key fisc metric weakness

--Moody's: India interest payment-revenue ratio key fisc metric weakness

--Moody's: India interest bill highest among invest grade nations

--Moody's de Guzman: No threshold for rating triggers, trend is key

 

By Shubham Rana and Pratigya Vajpayee

 

NEW DELHI/MUMBAI - As the Indian government trains its sights on a sovereign rating upgrade, it needs to drastically improve upon two key metrics to reach its goal – the size of its debt burden, and the affordability of its debt. The key to India’s rating upgrade lies in slashing not only the debt-to-GDP ratio, but also its affordability ratio or interest costs as a percentage of revenues, Christian de Guzman, senior vice president at Moody's Ratings said.

 

"The question that is being asked of us is what's it going to take for us to rethink our rating," de Guzman told Informist in an interview. "It is improvements in the debt-to-GDP, and more importantly, improvements in debt affordability."

 

The government has been pitching that India, which is currently rated at the lowest rung of investment grade at Baa3 by Moody’s, deserves a much higher rating because of its economic resilience and stable fundamentals.

 

Even though the Indian government has brought down its fiscal deficit by 440 basis points over the last three years, de Guzman pointed out that its debt metrics leave a lot to be desired. "India's debt to GDP (ratio) is a key weakness, but interest payments to revenue is an even weaker point of our underlying assessment of fiscal strength," he said.

 

For the Centre and state governments combined, the interest payments to revenue ratio is around 25%, which means 25% of revenue is dedicated to debt servicing. This is "by far the weakest amongst all investment grade countries" and much higher than the sub-10% median of 'Baa' rated countries, de Guzman said.

 

Moody's has previously said that it expects India's general government debt to stabilise above 80% of GDP over the next three years, down from 89.3% in 2020-21 but one of the highest among similarly rated peers. It also forecasts general government interest payments to fall to around 24% of general government revenue over the next two years from over 28% in fiscal 2020-21.

 

The government's intent to focus its fiscal consolidation efforts on bringing down the debt-to-GDP ratio post 2025-26 aligns well with the pursuit of a higher rating, de Guzman said. "We're not looking at deficits per se. We emphasise the debt burden," he said.

 

"If this fiscal policy is anchored by this notion that you want to keep a downward trajectory in the debt burden, and that does lead to improvements in debt affordability, I think it can be positive (for the rating)," he added.  

 

Following are the edited excerpts from the interview:

 

Q. What is your 2024-25 GDP growth estimate for India?

A. We do put out regular quarterly updates with regards to our growth assumptions for the G20 and we are towards the end of that latest round. Given the very robust performance that we have seen this year, we will be upgrading our forecast for India. So this macro board report will be published by the end of the month.

 

Q. The Reserve Bank of India has projected growth at around 7.2%. Do you see any risk to that outlook?

A. The more prominent risk to the outlook for Asia-Pacific economies as a whole, and not just India, is the external situation. We have flagged over the past few quarters and even heading into 2024, the possibility of a deceleration in the major economies to translate into slower growth for exporters, including India.

 

Having said that, I want to note that the US economy's performance has exceeded our expectations. We are firmly in that soft landing view. However, we're also wary of what's going on in China and of the troubles there.

 

At this point, in terms of the key risks to the growth outlook for India, the most prominent ones appear to be externally driven, not just the slowing of these economies but also what could happen geopolitically that could then basically replicate what happened over the past couple of years--higher commodity prices for example resulting from geopolitical conflicts elsewhere. This then translates into higher inflation which could then undermine the robustness of domestic demand in India.

 

Q. Moody’s had said after the result of the Indian General Election that the slim margin of victory for the NDA government might impede progress on fiscal consolidation. Since then, the government has set an even lower fiscal deficit target for this financial year. What is your medium term view on India's fiscal deficit, and just a broader view on where do you think the fiscal consolidation will go post 2025-26 when the target is 4.5%?

A. We need to place those comments into perspective, the comment about the relatively slim margin of victory. It's still a victory. Yes, the BJP does not have as large a share in Parliament and it has to form a coalition, but it is still a comfortable Bharatiya Janata Party-led government.

 

Having said that, because the representation in Parliament is not as strong or as bulletproof, we think the policymaking process is going to be that much more consultative and that means that some of the reforms that otherwise would have been rammed through in a very heavily BJP-led government are going to be a bit slower. And that might also mean that reforms related to fiscal management--things like raising revenue through higher taxes or GST reform--may have to proceed at a much more cautious pace given the political backdrop.

 

The government has not committed to any really aggressive fiscal consolidation beyond achieving the 4.5% GDP target by next year. We think that that target is increasingly credible, just given their ability to maintain that path of fiscal consolidation over the past couple of years. So with that expectation, and with the communication that the finance minister has done in the budget that they are going to be looking at anchoring fiscal policy on the debt trajectory, we don't have expectations of very rapid fiscal consolidation beyond the 4.5% of GDP by FY26.

 

We don't think we are going to get the fiscal deficit of 3% of GDP anytime soon, but I don't think that's the intent. The intent now is to stabilise and to bring down debt, not very aggressively, because I think they are wary about the potentially negative impact of very aggressive fiscal consolidation on the economy. So I think fiscal consolidation is going to be gradual, but on a sufficiently positive trend to improve the debt trajectory. 

 

Q. How does a relatively gradual consolidation post-FY26 impact any chances of a rating upgrade for India?

A. When we assess the credit rating of India, we look at several factors. We don't necessarily look at deficits solely as the trigger for potential rating movements.

 

We have sub-assessments of the economy, which is very strong. We have an underlying assessment of institutions and governance strength, not just of the government, but also the RBI. That's very stable. Another assessment on what we call susceptibility to event risk, which includes political risk, external vulnerability risk, government liquidity risk, and bank sector risk. All of these are stable.

 

Then we also have another assessment on fiscal strength. We're not looking at deficits per se. We emphasise the debt burden. The Indian government aims to have a downward trajectory in the debt burden, in the debt as a share of GDP, but not a very aggressive one. So it's going to remain high. Relative to Baa-rated peers globally, India has the third-highest debt burden.

 

But the other thing that we look at is debt affordability. It's basically how flexible are your fiscal finances when we consider how much of your revenue is devoted to debt servicing. So interest payments to revenue. India's debt to GDP is a key weakness, but interest payments to revenue is an even weaker point of our underlying assessment of fiscal strength.

 

On a general government basis, the interest payments to revenue ratio is around 25%. So, 25% of revenue is dedicated to debt servicing. And this is by far the weakest amongst all investment grade countries. What would basically lead us to re-examine where the rating is at the moment is material gains or material improvement in debt affordability.

 

What does that mean? In terms of what policy can do, it's really about the revenue side. And I just mentioned how difficult it may be to effect revenue reform against this political backdrop. I think that would be key in terms of improving the debt affordability ratio.

 

Q. What would be the average interest payments-to-revenue ratio for similarly rated peers?

A. So the median interest payments-to-revenue ratio of Baa-rated peers is going to be less than 10%. The two Baa-rated countries that have a higher debt burden than India are Italy and Spain. And their debt ratios are worse. They're over 100% of GDP, both of them.

 

But when you look at their financing costs, which is linked to the European Central Bank's policy rates, as a result of those very low interest rates, the debt affordability ratios of both Italy and Spain are around 6%. So the difference versus India is quite large.

 

Why do we care so much about debt affordability? It is because of fiscal flexibility. The money that is being spent on interest costs could be spent on other things. In the case of Italy and Spain, they are spending it on welfare, on ageing-related costs. They have very advanced ageing demographics, which is an advanced economy problem.

 

India, of course, is on the other end of the spectrum with a very young population, which is helping to drive growth. The point is, there is an opportunity cost with regards to having so much of your fiscal resources being devoted to just debt servicing. And debt servicing is directly linked to the amount of debt you have.

 

The Indian government has rightfully emphasised infrastructure spending and that has been the big fiscal story apart from the developments related to fiscal consolidation, in particular, over the past couple of years. The demonstrated ability of the Indian government to push through infrastructure spending, that's all very commendable. And it is at historically high levels. But the amount of money that is being spent on interest costs is still larger than that very large amount being spent on infrastructure.

 

Q. So, is the government's approach of focusing on reducing debt instead of targeting the fiscal deficit the correct way of going about things from a perspective of rating?

A. We don't provide policy advice, it's not our place to say whether it's the correct way. The question that is being asked of us is what's it going to take for us to rethink our rating?

 

It is improvements in the debt-to-GDP, and more importantly, improvements in debt affordability. If this fiscal policy, anchored by this notion that you want to keep a downward trajectory in the debt burden, and that does lead to improvements in debt affordability, I think it can be positive.

But there are other things that go into that as well.

 

Q. For a country with India's growth rate, what would be a good level of debt affordability ratios?

A. When we outline some of these triggers, what would move the rating up and down, we don't like to typically explicitly specify a number or threshold. Because what's more important is the trend.

 

What we have seen in the case of India is that there hasn't really been a material strengthening trend for debt affordability, despite positive trends related to revenue.

 

What are those positive trends? There's traction on GST. We're only starting to see the benefit of GST over the past couple of years. And then there's gains in terms of revenue buoyancy from digitalisation. There's improved compliance, you are broadening the base because it is easier to assess and pay taxes. All these have been positive for revenue buoyancy.

 

However, when you scale revenue to interest payments, we haven't really seen that much of an improvement over the past couple of years.

 

Q. What do you think state governments can do? Not only are their debt levels high, their deficit levels are also relatively high. Do you think state governments can be a problem for India's general government debt to GDP ratio to come down?

A. Yes, I think it has been a problem, historically speaking. We don't have any ratings on any of the states, so, it's hard for us to get into any detail. But in aggregate, I think we have seen that some of the negative impact from state fiscal goals has been somewhat ameliorated over the past few years.

 

I think they have largely complied with the 3% of GDP borrowing limits over the past couple of years, which stands in contrast to what we saw before, when there was much more evidence of a lack of fiscal discipline on the part of the states. So, in aggregate, yes, it still weighs on our assessment of overall fiscal finances, overall general government fiscal finances. But not as much as it had previously. But nevertheless, it still weighs negatively.

 

Q. Earlier in the conversation, we had talked about the relatively slim majority that the NDA has, which you said will not hamper, but it won't allow BJP to run through the reforms that they could have otherwise done. In your assessment, is political instability at the Centre's level, a risk at all right now?

A. We don't think so. Political risk is a part of our assessment, both domestic and geopolitical. So, our assessment of geopolitical risk incorporates some of the tensions with neighbours, which sometimes periodically devolves into conflict. It hasn't been significant enough to affect economic or fiscal performance. So, periodic issues with both China and Pakistan, both nuclear-armed neighbours, do form part of our assessment of overall political risk.

 

On the domestic side, I think we have noted the perceived increase in political polarisation on the ground. And we don't see that going away, even though perhaps there will be a more consultative manner of policymaking in Parliament. But we do recognise that there has been political polarisation on the ground, there has been what seems to be an increasing incidence of sectarian violence as well, such as notably in Manipur recently. But, these are the things that go into our assessment of political risk. But the stability, so to speak, of the government is not necessarily one of those things that we are worried about. It's other things that we are worried about that fall under the rubric of political risk.

 

Q. A recent Moody’s report had mentioned that water shortage in the country can actually hit India's sovereign rating. How big an issue is it right now in the overall scheme of things for India's rating?

A. We do have a very negative assessment of India's susceptibility to water risk. I think that that was the key point of that report. And this can manifest itself in terms of the implications for things like agriculture when there is a lack of a favourable monsoon. But, when you don't have that favourable monsoon, there are implications for agricultural production. So, there is that water security risk. And of course, the availability of potable water for consumption is another angle that we have been exploring.

 

As to how much does it actually affect the rating, it's rather indirect, so I would say it's not very material at this point.  

 

End

 

Edited by Vandana Hingorani

 

 

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