India - Foreign Direct Investment and India’s Sovereign Rating Trajectory
Author : Gaurav Joshi, Consultant and Banker
FDI and relationship with Sovereign Ratings
In general, investments in emerging markets offer a higher rate of return but also carry much more risk. To assess country risk, ratings is one of the factors which investors normally look at. Without ratings, it would be very difficult for a country to attract capital. As the number of rated countries increased, so did the amount of capital flows. Various studies suggest impact of sovereign ratings particularly for portfolio bond flows, FDI and other elements of the financial markets. They usually impact a country’s equity, bond, credit default swap and currency exchange markets and usually have spill-over effects. FDI flows to countries whose own regional ratings is high. When other regions’ ratings are higher, then there is a FDI crowding out effect and FDI flows to the higher rated regions.
India - Outstanding Rating and Recent Rating Action
Government of India – Current Ratings
JCRA on India
Japan Credit Rating Agency (JCRA) currently has the highest rating on India at BBB+/Stable last affirmed on August 29, 2019 supported by (a) buoyant economic growth potential, (b) improving macroeconomic stability and (c) ample foreign exchange reserves. The ratings are, on the other hand, constrained by (a) India’s infrastructure and business environment which still require improvements, (b) the bottlenecks to export growth, (c) looming non-performing assets of public sector banks (PSBs) and (d) need for sustained fiscal consolidation.
R&I on India
In March 2020, R&I Rating and Investment Information Inc. (R&I) affirmed India’s rating at BBB/a-2, Stable based on the following rating factors
As per R&I, the primary focus will be on how much investment the government can invite by moving forward with structural reforms. With uncertainty growing over the economic outlook, attention should be paid to developments in the fiscal deficit. The slowdown in economic growth is partly attributable to malfunction in the domestic financial system. The current challenge is to enhance the contribution of the financial system to economic growth by accomplishing drastic resolution of non-performing loans and reforms for the state-owned banking sector. In the medium term, it will be necessary to review priority-sector lending norms and other rules.
DBRS on India
Two months later on 21st May, 2020 DBRS which rates India, at BBB changed the rating outlook to negative from stable. As per DBRS “India arrived to the crisis in an already weak economic environment, with growth slowing to a decade low and limited fiscal space. If the shock proves durable, India’s credit profile could be negatively impacted by a combination of weaker growth and larger fiscal deficits, over the medium term, both of which would contribute to a rising public debt burden. The trend could return to stable if the economic, fiscal and financial impact of COVID-19 proves to be largely temporary. In this context, structural consolidation of the fiscal accounts and productivity-enhancing reforms would be credit positive”. DBRS will change India’s rating/outlook over the medium term if the post pandemic fiscal and growth dynamics puts the public debt ratio to a firm downward trajectory.
Moody’s on India
On June 1, 2020, Moody’s downgraded the ratings for India from Baa2 to Baa3 maintaining the rating outlook at negative. Moody's also lowered India's long-term foreign-currency bond and bank deposit ceilings to Baa2 and Baa3, from Baa1 and Baa2, respectively. Baa3/BBB- is lowest investment grade and a downgrade would mean pushing the country's sovereign rating to junk status, making overseas borrowings by corporates costlier. The credit profile of India (issuer rating Baa3) reflects the country's "a2" economic strength, which balances the large scale and diversification of the economy with a low GDP per capita and slowing rates of growth; "ba1" institutions and governance strength, which balances progress toward economic and institutional reforms in the past few years against increasingly challenging implementation and uncertainty about their effectiveness in addressing key credit challenges; "b2" fiscal strength, underpinned by India's relatively high general government debt burden and low debt affordability mitigated somewhat by a large and stable domestic financing base for government debt; and "ba" susceptibility to event risk, reflecting contingent liabilities and constraints to growth from the financial system, driven by banking sector risk and stress among non-bank financial institutions.
As per Moody’s release “The decision to downgrade India's ratings reflects Moody's view that the country's policymaking institutions will be challenged in enacting and implementing policies which effectively mitigate the risks of a sustained period of relatively low growth, significant further deterioration in the general government fiscal position and stress in the financial sector. The negative outlook reflects dominant, mutually-reinforcing, downside risks from deeper stresses in the economy and financial system that could lead to a more severe and prolonged erosion in fiscal strength than Moody's currently projects”.
Further as per Moody’s “Although a rating upgrade is unlikely in the near future, Moody's would change the outlook on India's rating to stable if outturns and policy actions were to raise confidence that real and nominal growth will rise to sustainably higher rates than Moody's projects, including through measures which enhance financial stability by strengthening the supervision, regulation and capitalization of the financial sector. Commensurate action to halt and reverse the rise in the debt trajectory, even slowly, would also support a stable outlook. An upgrade of the ratings is unlikely in the near term. However, the rating could be upgraded over the medium term if the post-pandemic fiscal and growth dynamics put the public debt ratio to a firm downward trajectory”.
S&P on India
On 10th June 2020, S&P affirmed the ratings for India at BBB- with a stable outlook. As per S&P “The ratings on India reflect the country's above-average real GDP growth, sound external profile and evolving monetary settings. India's strong democratic institutions promote policy stability and compromise, and also underpin the ratings. These strengths are balanced against vulnerabilities stemming from the country's low per capita income and consistently elevated fiscal deficits that contribute to high general government debt, net of liquid assets.”
Fitch on India
More recently Fitch affirmed India’s ratings at BBB- while revising the outlook to negative on 18th June 2020. The revision in the outlook to negative is owing to the following key rating drivers for India ‘The coronavirus pandemic has significantly weakened India’s growth outlook for this year and exposed the challenges associated with a high public debt burden. The medium-term fiscal outlook is of particular importance from a rating perspective, but is subject to great uncertainty and will depend on the level of GDP growth and the government's policy intentions. The relatively closed nature of India's capital markets, with limited foreign portfolio inflows, supports the authorities' ability to finance wider fiscal deficits domestically..
Tasks for Policy Makers
Recent challenges on the ratings front for India are emanating from current weak economic environment and likely fiscal slippages due to expected lower tax collections and policy one-offs leading to a gradual rise in the debt metrices. Increase in inflation reduces the room for further rate cuts. The negative impact of a rating change is mostly felt by the corporates as it makes the overseas borrowings by corporates costlier. Given the conservative outlook of International Rating agencies for India in the short term, for India to achieve a rating upgrade in the medium term once the temporary impact of the COVID is seen through and India’s starts showing improvement in the macro-economic situation, what could policy makers immediate focus be?
Since the last fiscal crises, India has clearly delivered on multiple fronts with respect to the reforms agenda - be it making the country an attractive destination from the Investment perspective as evidenced by the improvement in its Doing Business Rankings or becoming a more responsive nation on the implementation of the Sustainable Development Goals. By far the biggest improvement has been in India’s ranking in the Doing Business Survey in the last few years where India’s rank has improved to 63rd position (Doing Business 2020 study) from 77th position in the previous year and 142nd position in 2014. In Doing Business 2020 study, India along with other top improvers implemented a total of 59 regulatory reforms in 2018/19—accounting for one-fifth of all the reforms recorded worldwide. Important also to note that as per the current methodology the reforms implemented in Delhi and Mumbai are only considered though we shall soon start seeing the inclusion of two more cities by World Bank in its assessment.
“India’s impressive progression in the Doing Business rankings over the past few years is a tremendous achievement, especially for an economy that is as large and complex as India’s. Special focus given by the top leadership of the country, and the persistent efforts made to drive the business reforms agenda, not only at the central level but also at the state level, helped India make significant improvements,” said Junaid Ahmad, World Bank Country Director in India. “The focus now needs to be on continuing this trend to maintain and improve its ranking.”
There have been a slew of reforms since May 2019, both on the tax front, consolidation of the banking sector and also on the agricultural marketing front. India is committed to pursue the path of reforms.
This leaves us to wonder where exactly is the issue and what needs to be fixed. The biggest challenge which India faces is on maintaining its balance sheet and debt metrices. The last few years after the last major fiscal crises in 2012 had seen successive Governments take a number of steps to put the economy back on track, through increased investments and cut fiscal deficit. However, even though the aggregate fiscal deficit had been on a rise but for Central it was still being maintained in the mid 3% range expect for the year ended 2019-20 when it went up sharply to 4.6%.
RBI’s debt management strategy revolves around three broad pillars, viz, low cost, risk management and market development. The same is of important consideration for the International rating agencies. As per the Status Paper on Government Debt (April 2020) Institutionally, the Government has decided to set up a statutory Public Debt Management Agency (PDMA) to bring both, India's external and domestic debt under one roof. The first step towards this direction was the establishment of a Public Debt Management Cell (PDMC) within Budget Division, Ministry of Finance in 2016, subsuming the erstwhile Middle Office. Considering the extant legal provisions, the role of PDMC is in advisory capacity for the Central Government debt management. The PDMC has since been working in the Budget Division discharging its responsibilities and moving forward towards establishing a PDMA. Government needs to have an active debt management strategy.
Gross Fiscal Deficit and Trend
Gross Fiscal Deficit (GFD) as a percentage of GDP had been on a declining trend since FY 2012-13 expect during the FY 2019-20 when it has jumped to 4.6%, the 2nd highest in a decade. Though estimated to marginally increase to 3.8 per cent in 2019-20 (RE) as set in February 2020, the surprise element has been the actual number at 4.6% as a percentage of GDP. It is difficult to estimate what the number would be for 20-21 given the uncertainty in the backdrop of Covid related extended lockdown though from April 2020 it has been partially lifted in stages. Economists are divided with some even suggesting the number to be as high as early teens, first time in a decade if the lockdown extends for much longer. The saving grace so far have turned out to be monsoons this year.
As per IMF “The high borrowing requirement of the public sector also holds India back as it strives to catch-up with more advanced countries by making private-sector investment more costly. Investment activity—whether public or private—relies on a finite pool of financial resources. In India’s case, households’ net financial savings have been lower than the public sector borrowing requirement in recent years, implying that private investment projects face stiff competition for funding, making financing more costly and preventing potentially viable projects from being initiated.”
During the last crises, the fiscal deficit in 2012-13 was contained below the budgeted 5.2 per cent after it had touched a high of 5.9 percent in 2011-12. What was more important the Government showed a path and commitment to the rating agencies that it would further bring it down to 4.8 per cent in the next fiscal. Analyses of the debt parameters brings forth some interesting observations for the latest available year as per the Status Paper on Government Debt available for 2018-19 dated April 2020:
As per the status paper of Government debt the salient features of Central Government debt are as under:
- General Government Debt (GGD)-GDP ratio worked out to 68.6 per cent at end-March 2019, slightly lower compared to 68.7 per cent at end-March 2018.
- 94.1 per cent of total Central Government debt at end-March 2019 was domestic debt.
Sovereign external debt constituted 2.7 per cent of GDP at end-March 2019, implying low currency risk to GoI debt portfolio. The sovereign external debt is entirely from official sources, providing safety from volatility in the international capital markets.
- The share of marketable securities in internal debt stood at 84.4 per cent at end-March 2019, slightly lower than 86.1 per cent at end-March 2018.
- Public debt in India is primarily contracted at fixed interest rates, with floating internal debt constituting 0.9 per cent of GDP at end-March 2019, thereby insulating debt portfolio from interest rate volatility and providing stability to interest payments.
- The Government continued its efforts to elongate the maturity profile of its debt portfolio with a view to reduce the roll-over risk. The weighted average residual maturity of outstanding dated securities at end-March 2019 was 10.4 years with the tenure of the longest security being 37 years.
- At end-march 2019, 28.27 per cent of outstanding stock of dated government securities had a residual maturity of up to 5 years, indicating a relatively lower roll-over risk in the medium-term, which is further supported by active debt management operations in the form of switches/conversions.
- Ownership pattern of dated securities indicates a gradual broadening of market over time. Commercial banks remain the dominant holders even as their share declined from 43.9 per cent at end-March 2013 to 40.3 per cent at end-March 2019. Insurance companies and provident funds accounted for 24.3 per cent and 5.5 per cent, respectively, of outstanding stock of dated securities; creating stable demand for long-term securities.
- IP-RR ratio (interest payments to revenue receipts) of the Centre was 37.5 per cent in 2018-19 as compared to 35.6 per cent in 2012-13. Average interest cost (AIC) of the Centre remained unchanged at 7.1 per cent for the same period. The IP- RR ratio and AIC for States at end-March 2019 stood at 11.2 per cent and 7.0 per cent, respectively.
As per IMF “Economic development projects and enhanced social initiatives in India will be vital in the coming years. But to generate the revenue needed to get them off the ground, India’s debt—among the highest in emerging markets—must be reduced. Despite some improvement in reported fiscal deficits, debt as a share of GDP remains little changed over the past decade partly due to increases in off-budget financing”.
Foreign Exchange Reserves – Provide Buffer
The external debt to GDP ratio stood at 20.6 per cent at end-March 2020, with the foreign exchange reserves at a decade high.
What next?
The negative outlook usually means that there is at least a one-in-three likelihood of a downgrade within the next 12 months. Negative rating action on a Sovereign has multiple negative connotations as it is also normally accompanied by downward revision in the country ceilings and transfer and convertibility assessments which affects the ratings of the corporates making the costs of funding dearer.
In India’s case when the rating agencies had taken a negative rating action in 2012, the same resulted from rising macroeconomic concerns which were a combination of slower real GDP growth, high inflation pressure in the wake of inadequate economic reforms, problems related to land acquisition and environment clearance which were taking a toll on fixed investment activity and slowdown in fiscal consolidation process. At that time rating agencies also felt that the country’s long-term physical infrastructure needs were effectively constraining the economy’s long-term capacity to grow. Currently policy makers are busy tackling economic slowdown which have lead to widespread job losses, crises facing the banking sector – capital needs, debt moratorium and likely NPL issue once the moratorium ends, shortfall in Government tax collection and India trying hard to get an Investment friendly nation status to attract likely flight of capital from other nations.
Except for investments in few sectors and corporates, India has had a challenge to attract long term investors on a large scale which is much below its potential. As such need of the hour is to provide an operational environment for business and private investments to improve long term growth potential. Faster implementation of the ‘Ease of Doing Business’ criteria across all States and Union Territories could unleash a competitive spirit to attract capital amongst states. An improvement in India’s investment climate that supports greater infrastructure investment would have a multiplier effect supportive for India’s sovereign ratings. Increased focus on SDG 9 Industry, Innovation and Infrastructure will help address some of the challenges.
As per the UN SDG reports, on the social assessment, India alone represents 23.1% of the total achievement gap on SDG 2 (Zero Hunger). If India eradicates undernourishment (currently at 14.8% of the Indian population) the world will be 25.2% closer to having achieved the SDG target on undernourishment. Innovative initiatives are being introduced to modernise the agriculture and arrest the negative impacts of climate change. Agriculture, forestry and fishing contributed to 14.64% of the GVA at basic price by economic activity during 2019-20 (PE) as against 14.62% in 2018-19 (1st RE). Recent approval from the Union Cabinet to liberalize the regulatory environment through amendment to Essential Commodities Act and the approval granted through necessary ordinance to promote barrier-free inter-state and intra-state trade in agriculture produce will reduce wastage and help check prices besides improving the farmers income. Farmers have also been empowered to engage with processors, aggregators, wholesalers, large retailers and exporters.
Another good news is coming wrt live storage status of 123 reservoirs of the country as per Central Water Commission latest 20.08.2020 bulletin. Of these reservoirs, 43 reservoirs have hydropower benefit with installed capacity of more than 60 MW. The total live storage capacity of these 123 reservoirs is 171.090 BCM which is about 66.36% of the live storage capacity of 257.812 BCM which is estimated to have been created in the country. As per reservoir storage bulletin dated 20.08.2020, live storage available in these reservoirs is 109.937 BCM, which is 64% of total live storage capacity of these reservoirs. However, last year the live storage available in these reservoirs for the corresponding period was 122.616BCM and the average of last 10 years live storage was 102.691BCM. Thus, the live storage available in 123 reservoirs as per 20.08.2020 bulletin is 90% of the live storage of corresponding period of last year and 107% of storage of average of last ten years. (http://cwc.gov.in/reservoir-storage)
The challenges in India’s macro-economic position today are a bit different than what they were in August 2012. We have a slew of economic reforms including GST and India’s position in the ‘Doing Business Survey’ has vastly improved since 2012. This is also a global crises. Post this crises Indian economy is likely to enter a new phase of strong growth. Due to the benign oil prices, we don’t have a twin problem of high fiscal and current account deficit unlike the past.
India's economic growth has slowed to a decade low of 4.5% in 2019-20 (5% in 2012-13). ICRA had forecasted in July’20 that the Indian economy might contract to 9.5% in FY 21. India’s 2020 growth forecast is revised down from -2.5% to -4.6%, followed by growth of 6.8% in 2021 as per OPEC’s latest forecast in August 2020 (was projected at 6.5 % in 2013-14 during the previous rating crises). The economy activity is likely to benefit from the slew of steps taken by the government, good monsoons so far and relatively low global oil prices. The OPEC Reference Basket (ORB) averaged $43.42/b in July, gaining $6.37 over the previous month to reach its highest value since February this year (OPEC MOMR August 2020)..
As highlighted by IMF, India needs to recommit to debt reduction by reducing its public sector borrowing program. Constraining India’s current rating are the high government debt burden and deficit and weak fiscal profile. India has demonstrated in the past that it has the ability to do a course correction and achieved fiscal consolidation. The path to a rating change is dependent on the same. To achieve a change in rating outlook Government of India would need to
- Demonstrate its commitment to maintain fiscal targets and reduce its deficits.
- The proportion of the Government’s share in the savings rate needs to improve
- Maintain inflation within the RBI target range and possibly at the lower end of the target which otherwise has the danger to erode the private savings
- Increase its tax base further and the GST mechanism should become seamless
- There should be meaningful improvement in public finances
- Improvement in Infrastructure supported by larger foreign direct investment flows
Building Blocks of India’s credit story
Economic and Financial Situation
The diversified structure of India’s approximate USD 3.202 trillion nominal (USD 11.321 trillion PPP basis) economy, its robust growth over the past decade and its strong growth potential are its key ratings strength. Returning to the fast path of growth should be a priority of the Government. India achieved a growth of 4.2% as per the provisional estimates during FY 2019-20 as against -4% estimated by Moody’s in their base assessment. Higher GDP growth together with the Government’s steps towards fiscal consolidation will help realise the merits of economic expansion.
India’s current account deficit is expected to turn positive as per SBI research at around 0.7% of GDP for FY21. Further India’s Gross Domestic Savings were at ~30.1% for FY 2019 and are expected to remain high. The availability of a large pool of domestic savings significantly reduces the risks associated with financing annual deficits and maturing debt. Further India’s current external payments (CXP) cover is likely to be comfortable.
GST and the more recent agriculture sector reforms have been key reforms undertaken by the Government in recent times and the process of financial deepening is well underway.
Reserve Bank of India has demonstrated strong commitment to curb inflation.
v India would continue to focus on longer term development issues such as addressing infrastructure constraints and investment promotion raising industrial and export competitiveness, supported by larger foreign direct investment inflows. Roll out of DOING BUSINESS COMPETIVENESS CRITERIA pan India can be one of the options to bolster reforms.
v Indian Government’s ability to fund itself in domestic capital markets would need to be complemented further by lowering the funding costs and elongating the debt maturity profile further.
v Both the Central and States Governments would need to demonstrate strong commitment to the structural reforms program backed by explicit debt-reduction targets.
Political and Business Environment
Democratization, fiscal decentralization and improved economic performance provide broad support to the Government. In the latest Doing Business Report (DBR), 2020, India stands at 63rd position out of 190 countries. Since 2014, India’s rank has improved from 142 (DB 2015 report) to 63 in 2019. India was at 134th position during 2011. The roll out of State wise rankings would usher in the next phase of reforms.
Fiscal and monetary policy has become increasingly transparent over time. The need is for
v Early enactment of the “new Fiscal Responsibility and Budget Management Act”
v Meaningful improvement in public finances and cost competitiveness.
v Improving efficiencies and performance of the country’s state-owned enterprises would reduce dependence on the government for financial support.
The SDG Index and Dashboards Report is the first worldwide study to assess where each country stands with regard to achieving the Sustainable Development Goals (SDGs). As per the 2019 SDG Index and Dashboards, India with a score of 61.1 is today ranked 115 (out of 162). As per the 2018 report, India had a score of 59.1 and was ranked 112 (out of 156).
India, home to one-sixth of all humanity, holds the key to the success of the 2030 Agenda. India in its second VNR has made a paradigm shift to a “whole-of-society” approach with Government of India engaging sub-national and local governments, civil society organizations, local communities, people in vulnerable situations and the private sector. The absolute performance gaps are high in 20s in 9 out of 17 SDGs in case of India. Early bridging of the same will help in the environmental, social and governance risks assessment.
This would provide the basis for an improving credit story and hence higher ratings for India.
The views expressed here are personal views of the author.