While India has undertaken a slew of reforms over the last four years, that got Moody’s Investors Service to raise the country’s creditworthiness for the first time in more than a decade, another ratings change is not expected in the immediate future, and with general election fast approaching in 2019, the government is expected to remain committed to its fiscal deficit target of 3.3% this financial year, William Foster, vice-president-senior credit officer, sovereign risk group, Moody’s Investors Service, said in an interaction.

Despite reforms, Foster pointed out that India was confronted with a series of challenges on the external front—oil prices, rising interest rates, and an uncertain trade environment.

“What’s important to remember is that India is in a better place today than in 2013, during the taper tantrum. Foreign exchange reserves are at an all-time high, the current account deficit even though it has widened recently, is still half of what it was in 2013, and we expect it to be close to 2.5% of GDP this year—so the vulnerabilities on the external front have diminished and the capacity to deal with it has improved as well," he added. Edited excerpts:

You’ve tracked India for a while. What is your reading of the current situation? All factors that were once favourable to India—low crude prices, falling fiscal and current account deficits and low inflation —these appear to be reversing.

The thing to focus on is what policymakers are doing to address the challenges at hand. Over the past few years, both the previous and the current government have focused on addressing key challenges. What we have seen from a medium-term perspective over the last few years is that—and this has reflected our decision to upgrade (India’s sovereign rating for the first time since 2004) from Baa2 from Baa3 in November 2017—the reforms India undertook to addressing key issues. For example, with regard to the fiscal side of things, focusing on medium-term physical framework that focuses on bringing down the debt burden over time for the new FRBM (Fiscal Responsibility and Budget Management Act) recommendations, and its commitment to a fiscal consolidation roadmap that will feed into that over time. On the revenue side, which is particularly important for India—it was about trying to figure out ways to broaden the tax base, and bring more economic activity into the tax net, to bring the very low tax-to-GDP ratio up to contribute to revenues, which can then feed into higher spending on capital formation and infrastructure etc. This government has been focused on that over the last few years. GST (goods and services tax) is an important reform—everyone realizes the importance of that. We believe things like demonetisation, tax incentive schemes and other measures that are improving the potential for people to pay taxes, and also the administration behind that to enforce tax payment is improving slowly in India. That is an important change we have seen in last three years.

In addition to that, there has been a series of reforms around attracting FDI, and changing restrictions around FDI, changing the ease of doing business indicators—these don’t happen overnight and they are not seamless, but India has been trying to address these issues, which is helpful for future growth. The banking system obviously is an issue, which is weighing on the credit profile—the way we look at it, it is a contingent liability on the government. There are continuing challenges on the twin fiscal and current account deficits. The step that was taken to formally build the Insolvency and Bankruptcy Code (IBC) was a very important one as India did not have a formal resolution mechanism to deal with this. Recognizing them is one thing—there’s a lot of transparency being shown in the banking system now, but how do you deal with NPAs, and finally, for the first time there’s a system in place to try to work those out. What is encouraging is that, we are starting to see some of the fruits of that starting to come to the fore. There is a system now in place, we are starting to see recoveries that are a little higher than what people were estimating, and ultimately over time, this will build a track record of cases that eventually can be used in future for speeding up the process—that is really important. Not only was this weighing on banks, but it was also important for the bond markets. This will help build the debt market in the future. These are building blocks in the medium term to lay the foundation for a stronger economy—higher tax collection and higher government revenue can be eventually put forward towards capital formation which can contribute potential growth in future.

What has changed is the external headwinds, and this is global, and not specific to India. Oil prices being higher, and India being a net importer is going to suffer like other importers. Global interest rates are rising, and everyone is experiencing that. The trade environment is uncertain. What’s important to remember is that India is in a better place today than in 2013, during the taper tantrum. Foreign exchange is at an all-time high, the current account deficit even though it has widened recently, is still half of what it was in 2013, and we expect it to be close to 2.5% of GDP this year—so the vulnerabilities on the external front have diminished and the capacity to deal with it has improved as well. India was dealing with tailwinds from lower oil prices, now it is suffering from headwind of higher oil prices. Now you have a changing global environment where the cost of borrowing is higher. Again remember, India on a relative basis, and that is how we look at it from a sovereign perspective, and relative to other countries, India borrows much less from abroad, and they don’t borrow in foreign currencies, and so, those vulnerabilities are also much lower compared to other countries in the region. These things are helpful, and these are some of the factors that we considered when we upgraded India (last year).

There are a lot of challenges ahead still—India still has lot to do to continue to grow its economy. To get investment back on track and to attract more FDI, it needs to deal with its banking system… from our point of view, the most important key challenge is fiscal—bringing down that very large debt-to-GDP ratio which is very high compared to its peer group. India’s debt-to-GDP ratio is at about 70% and it’s below 50% of its peer group—that is a big gap—and the commitment to bring that down over time is important for rating perspective.

What is the next step you want to see from India that will see a change in its ratings?

Change in the rating can happen anytime, but for India, we don’t expect any change in immediate future, because our decision last November was based on a stable outlook in the medium term. What can really move the needle for India in the future? Fiscal will be in the forefront of that—whether it is substantial improvement in debt-to-GDP ratio, based on a very strong fiscal performance, including raising revenues, and improving expenditure and management—higher nominal GDP growth, that will only be supported with credit, improving its banking system..… but the opposite case can happen too—if there’s fiscal slippage, if somehow government veers from the FRBM targets on a regular basis, or if you do not see an improvement in tax collections, or if you see significant expenditure beyond what was planned—all that will be negative.

In an election year, is fiscal slippage a concern—or, going by the government’s track record, you think it may not happen?

Track record is important, but what you do in future is very important as well. From my perspective, we think this year’s central government fiscal deficit target is 3.3% of GDP, and that is achievable—we think the government is committed to it, but there are risks around it. One of the risks is with regard to spending beyond what is planned in the run up to the election. There’s risk in the revenue side and expenditure side—on revenue side, it is on GST collections and given that it is the first year, it may be more difficult to collect even though we have relatively strong forecast. However, we saw that for the last couple of months, GST collections have been relatively encouraging. The main risk on revenue side really is oil—with higher oil prices that obviously put more pressure on people. Ultimately, the government could feel the pressure and be forced to revise the taxes on oil and lower it—if they do that, that will put more pressure on revenues and on fiscal deficit. On the expenditure side, we think that the main risk is the MSP (minimum support prices for farm produce) formula that hasn’t been fully defined yet—if that is higher than anticipated, that could be both inflationary and could also put more weight on the fiscal. In addition to that, as you said, any pre-election spending that is beyond budget will potential weigh as well. Our expectation is that the government, if it needs to, can always adjust discretionary spending particularly in capex to maybe offset some of those slippages —but, at this stage, we expect them to stay near that.

India has been seeing a cyclical recovery—but with oil inching up and interest rates moving up, do you see a slowdown in growth in the second half of FY19?

Our focus for GDP growth this year is 7.3%. We originally expected 7.5%, and the main reason for the revision was net exports—oil was weighing on that and also on consumption. We expect that to moderate somewhat, but basically, growth should continue to be supported by consumption, mainly rural consumption. Investment remains a challenge—it has not picked up to that extent that people would like to see. Rural demand remains strong and that has been supportive. Next year we expect higher growth—7.5%, and that’s based on the expectation that investment will start to pick up, as the twin balance sheet issues continue to be addressed. But there are risks around that. Whatever happens at the end of this year’s state elections, it can impact investors’ sentiments, and if there is a real change in terms of outlook, that can potentially change some of the factors.

What are people here asking you about India? Are they concerned on the chances of BJP-led government coming back, or are they concerned on earnings not coming back yet…

The questions are similar to that of last year —when’s investment going to pick up, when will the investment cycle turn, will government need to continue to recapitalize the banks, and when will that be worked out, and that is also related to lending. But the newer questions being asked are on external fronts—people are now asking about current account deficit, or oil prices and what does the rising interest rates globally mean for India. They are asking about the bond markets in India—yields have gone up and banks have taken mark-to-market losses in the balance sheet, and what does that mean for their profitability, and their (banks) ability to lend in the future? So these are new newer questions that were not in focus last year. And the other one is increasing attention on upcoming state elections —the possibility of varied outcomes of these elections. These are the questions we ask ourselves, and investors are asking us as well.

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