Moody's First India Upgrade in 14 Years Bets on Modi Reforms

Rupee and government bonds rally, stock markets surge
Moody’s says reforms reduced risk of sharp increase in debt

Indian Prime Minister Narendra Modi. Photographer: Dhiraj Singh/Bloomberg
Moody’s Investors Service raised India’s sovereign rating for the first time since 2004, overlooking a haze of short-term economic uncertainties to bet on the nation’s prospects from a raft of policy changes by Prime Minister Narendra Modi.

Rupee, bonds and stocks rallied after the ratings firm upgraded India to Baa2 from Baa3 and said reforms being pushed through by Modi’s government will help stabilize rising levels of debt. That’s a one-level shift from the lowest investment-grade ranking and puts India in line with the Philippines and Italy.

While government officials hailed the move as long overdue, some investors termed it a surprise given that India recently surrendered its status as the world’s fastest-growing major economy amid sweeping policy change. The upgrade could prove to be a big win for the ruling party, which is facing increasing attacks about the economic slowdown before key elections in Modi’s home state next month and a national vote early 2019.

The upgrade "reflects willingness of Moody’s to look beyond the transitory disruptive effects of difficult reforms," said Sumedh Deorukhkar, a Mumbai-based senior economist at Grupo BBVA. However, he said there must be "caution that several challenges for the economy, particularly a high debt burden and delayed labor and land acquisition reforms leaves little room for fiscal complacency, especially ahead of 2019 elections."

The rupee surged as much as 1 percent to 64.67 per dollar in Mumbai, the benchmark equity index rose 1.3 percent and the yield on the 10-year sovereign bond tumbled 11 basis points to 6.96 percent.

Cheaper borrowing costs will be a relief for the government and companies, according to Nischal Maheshwari, head of institutional equities at Mumbai-based brokerage Edelweiss Securities Ltd. Indian assets had sold off over the past weeks as rebounding oil prices threaten to worsen Asia’s biggest budget deficit, which would have made it costlier for the government to raise spending and boost growth.

Expansion in gross domestic product slipped to a three-year-low of 5.7 percent in the April-to-June quarter. Growth was hit by Modi’s move last year to invalidate almost 90 percent of currency in circulation and the subsequent implementation of a new consumption tax.

What Investors Are Saying About India’s First Upgrade Since 2004

The upgrade "makes a big difference to investors," said Avinash Thakur, managing director of debt capital markets at Barclays Plc. "We will see more dollar bond supply from India, like more public sector undertakings would be printing.”

Big Question
The question now is whether S&P Global Ratings and Fitch Ratings will follow, according to Nomura Holdings Inc., which expects the companies to wait for the government’s fiscal position before making any changes. The view is echoed by economist Gaurav Kapur at IndusInd Bank Ltd. -- who says they’ll wait until the budget announcement expected Feb. 1.

Fitch and S&P declined to comment on Moody’s action, and S&P reiterated Oct. 24 comments that "for an upgrade, India would have to address its weak fiscal balance sheet and weak fiscal performance." Both companies now rate India a notch below Moody’s.

Moody’s move "is an overdue correction,” said Modi’s Chief Economic Adviser Arvind Subramanian. "This is a recognition of India’s macro economic reforms. But it has also to be kept in mind that these are external factors. And the government will pursue its own reform agenda. And those will drive our economic development."

Moody’s action was in line with the Bloomberg Economics model -- which predicted an upgrade based on the divergence between actual ratings and CDS implied credit ratings -- and could tip the balance toward a rate cut when the central bank decides on policy Dec. 6, according to Bloomberg economist Abhishek Gupta. The Reserve Bank of India didn’t immediately reply to an email and text message seeking comment.

Mixed Results
Modi has pushed through sweeping reforms, with mixed results. Moody’s acknowledged that the cash ban and goods and services tax have undermined growth in the near term. In the longer term, however, the GST will promote productivity by removing barriers to interstate trade, Moody’s said, also citing Modi’s improvements to the monetary policy framework, measures to clean up bad loans, and efforts to bring more areas into the formal economy.

"While India’s high debt burden remains a constraint on the country’s credit profile, Moody’s believes that the reforms put in place have reduced the risk of a sharp increase in debt, even in potential downside scenarios," according to the firm’s release.

The government has also won praise from ratings firms for a $32 billion program to recapitalize banks that economists say will revive lending and stoke demand on the ground. However, the "sovereign upgrade in itself will not lead to a blanket upgrade for ratings of the lenders in the country,” Srikanth Vadlamani, a Singapore-based vice president of the financial institutions group at Moody’s, said by phone.

Moody’s forecasts GDP growth of 6.7 percent for the fiscal year through March 2018, with a pick up to 7.5 percent in the following year and "similarly robust" levels from 2019 onward. That’s in line with the median 6.8 percent and 7.4 percent estimates in a Bloomberg survey.

Populism’s Shadow
The upgrade adds to a string of good news for Modi. The World Bank said it’s getting easier to do business in India, with Asia’s third-largest economy jumping 30 places to rank 100th in the latest ranking released last month. Earlier this week, Pew Research Center said Modi remained a popular leader and public confidence in the economy and the overall direction had improved.

While these burnish Modi’s global credibility, questions have been raised at home about the health of the $2 trillion economy. Critics have questioned the wisdom of the cash ban and opinion polls show that while his party will win next month’s state elections, it could be a closer contest than what has been seen in decades.

Read: The State That Made India’s Narendra Modi Could Break Him

Moody’s is looking through the near-term political cycle ahead of state polls when "populism may overshadow reform momentum," according to Vishnu Varathan, Singapore-based head of economics and strategy at Mizuho Bank Ltd. The afterglow from the upgrade won’t last long given the emerging signs of quickening inflation and a widening current account and fiscal deficit, Varathan said.

— With assistance by Subhadip Sircar, Manish Modi, Shikhar Balwani, Arijit Ghosh, Nupur Acharya, Divya Patil, Anto Antony, Archana Chaudhary, and Ruth Pollard