The significant uncertainty about India’s sovereign rating has been removed by S&P, which has maintained its rating at BBB- with a stable outlook. Following Moody’s earlier demotion of India to a similar level with a negative perspective, a debate has been opened on how other agencies will react.
S&P’s position is more balanced as it takes into account the country’s challenges and opportunities, but it does not agree that the economy will recover in fiscal year 22 and grow by 8.5%, after a 5% decline this year. Given the strong foundations that could help counter the Kovid 19 strike, the outlook is clearly more optimistic.
Let’s see what positive elements the rating agency has found. There are three things that stand out. According to Covid-19, the initial growth prospects seem to be above average, which is quite realistic. Secondly, the external situation is very good. Contrary to expectations, foreign exchange reserves in the 20th and last financial year amounted to $500 billion. Apparently, this has been made possible both by the reduction in the DAC and by increased capital inflows, in particular through foreign direct investment and the ECB. This has strengthened the balance of payments and made India fundamentally strong in its external balance. Third, the credit rating agency recognised the changing monetary situation in which RBI had been more than active since the announcement of its closure in order to ensure a smooth flow of funds on a sector-by-sector basis and to establish a meaningful schedule.
However, three factors continue to give cause for concern. The first is the situation of the financial sector.
This is likely to apply to all countries that create room for borrowers through a moratorium and credit lines. It is to be feared that at some point this will be even more the case if the economy does not work. Despite the fact that FY 21 is not included in the table, it should be borne in mind that if the economy does not recover in FY 22, the NPA issue, to which the Agency has paid particular attention, may surface.
The problem for India is indeed that while the government has made significant cuts in expenditure, it has little control over revenue generation.
The second is the labour market. This is a paradoxical situation in which the issue of migrants has not yet been resolved because the necessary jobs are being lost. Constant restrictions also mean that even more jobs may be lost, which can be a challenge in the recovery phase. Some states have allowed redundancies which, while beneficial to the economy, may also have other social consequences for the government.
The S&P has also highlighted the fiscal tensions ahead, which is important because at the time of Covida-19 all governments were more flexible in their objectives. The problem for India is indeed that the government is rather strict in its spending, but has little control over revenue generation. The economic package is implemented to a greater extent through the financial system, which has a positive impact on budgetary indicators. The budget only covered the ancillary activities and did not exceed the costs. However, the expected sharp fall in revenues will lead to a double-digit general government deficit. The challenge is to get it back on track for financial year 22.
Indeed, the message is that growth in the financial year 2002 will be crucial for any new rating action and will in turn determine the financial sector and budget balances. The government is of course aware of these problems and will deal with them appropriately.
Writer – Chief Economist, CARE Rating.
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