Moody’s warns India on structure of government debt
New Delhi: The Indian financial system’s ability to absorb rising government debt could diminish significantly if the combination of low economic growth and high inflation persists beyond the next few quarters, potentially weakening the country’s sovereign credit profile, Moody’s Investors Service warned on Thursday.
Between 2002-03 and 2012-13, India’s general government debt as a proportion of gross domestic product (GDP) fell to 66% from 83%, despite a fiscal deficit that averaged 7% over that period. The drop in the government debt-to-GDP ratio was due to government debt and interest payments growing at a slower pace than nominal GDP growth.
Moody’s, however, warned in a report that if over the coming quarters growth slows significantly and inflation and interest rates remain high, government debt will revert to the high levels seen in 2000, unless the fiscal deficit is reduced significantly from the average of the last decade.
“Thus, growth, inflation, interest rate, and fiscal policy trends over the next twelve to eighteen months will determine whether domestic financing conditions will remain supportive of the sovereign credit profile over the next three to five years,” the credit assessor added.
Moody’s has a Baa3 rating on India, the lowest investment-grade rating assigned by the company.
India’s GDP growth slowed to 5% in the year ended 31 March, the slowest pace in a decade, from 6.7% in the previous year, as high inflation, borrowing costs and delayed project approvals forced companies to put investments on hold. In the first half of the current fiscal year, growth averaged 4.6% as consumer spending slowed.
Persistent inflation has forced up interest rates. Inflation based on the wholesale price index has been hovering around 7%, above the central bank’s comfort zone of around 5%.
The key to bettering India’s sovereign credit profile is to contain the fiscal deficit, which is already a priority for the government, said N.R. Bhanumurthy, a professor at the National Institute of Public Finance and Policy.
“Fiscal deficit needs to be compressed irrespective of growth reviving in coming quarters,” he added.
The government is committed to limiting the fiscal deficit to 4.8% of GDP in the current financial year ending 31 March, compared with 4.9% of GDP last year. The deficit widened to 94% of the full-year target in the eight-month period ended November from 80.4% in the year-ago period, making it more difficult for the government to meet the target.
Moody’s said its stable outlook on India’s ratings is based on the anticipation that GDP growth will rise from current levels over the next two years and inflation will decline modestly.
“Based on this expectation, the interest-growth differential is likely to remain supportive of the government’s current debt maturity, interest rate, and currency structure,” Moody’s said.
“If current conditions persist over the medium term, they could raise government expenditures while lowering revenues, thus increasing fiscal deficits; reduce the private sector’s capacity and willingness to save, thus shrinking the domestic pool of financing available to the government; and impair domestic banks’ asset quality, profitability, and deposit growth to an extent that lowers banks’ capacity to absorb government debt,” it added. “These developments could change the current favourable currency, interest rate, and maturity structure of government debt, such that the government’s interest and debt burden increase more rapidly than its revenues and GDP.”
Atsi Sheth, a Moody’s vice- president and senior credit officer, said in a statement that interest rates paid on Indian government debt have been significantly lower than India’s GDP growth rate, and this interest-growth differential has lowered the government debt/GDP and government interest payments/government revenue ratios over the past decade, despite wide fiscal deficits.
“As macro-economic imbalances have heightened in the last few years, the currency, maturity and interest rate structure of government debt has supported India’s sovereign credit profile and Baa3 rating,” said Sheth.
In the last three years, as interest rates have increased and growth has slowed, India’s interest-growth differential has narrowed, yet it remains more favourable than in many similarly rated countries, and is a factor underpinning government debt sustainability.
India’s government debt to GDP ratio was still the highest among major developing countries at 67.9 in 2013, compared with 60.3 for Brazil, 42.9 for the Philippines, 24.5 for Indonesia and 34.4 for Turkey.
Since Indian government borrowing is mostly domestic and it owes a very small portion of its debt in foreign currency compared to its peers, currency depreciation and changes in global financial conditions affected the Indian government’s borrowing costs less than they would have in countries where the proportion of foreign currency and international borrowing is higher, Moody’s said.