Moody's upgrades India's long term foreign currency rating to investment grade
Moody's Investors Service has upgraded India to Baa3 in two key rating categories due to a reduction in external vulnerability, rising foreign investment, and vibrant economic growth.
Moody's upgraded India's country ceiling for foreign currency bonds as well as the government's foreign currency issuer rating to Baa3 from Ba1. The outlooks for both ratings are stable.
In the same announcement, the agency revised upward its outlook on the Ba2 country ceiling for foreign currency bank deposits from negative to stable. The outlook on the government's Ba2 domestic currency rating remains negative.
Moody's said that the principal driver behind the rating changes is the reduction in external payments vulnerability. Official foreign exchange reserves have increased to nearly $100 billion, a $30 billion rise in the year since these ratings were last raised. This amount is more than twice the value of the country's external obligations coming due over the next year and is also nearly large enough to cover a full year's current account payments.
In addition to the external liquidity situation, the rating agency cites India's more resilient economic performance, evidenced during 2002's drought-induced shock when GDP growth nevertheless stayed above 4%. Forecasts for the current year's expansion have been adjusted upward to 8%. Going forward, growth is expected to be somewhat lower than this year, partly due to government dissavings. Still, growth will likely remain robust, the product of more than a decade of gradual structural reforms and market liberalization.
Moody's points to the promise of healthy earnings in the Indian equity and portfolio markets, in addition to enhanced confidence in local business prospects, as reasons for heightened investment and other capital inflows during the past year. Beyond the well-known opportunities for outsourcing and software services in the small but growing information technology segment, the restructuring of private and some public industry, which has benefited from the lowering of import tariffs and restrictions as well as foreign resource transfers, is being recognized by investors worldwide.
In Moody's opinion, the current account is likely to shift from a modest surplus position to small deficits in the next two years because of vigorous import demand, although capital account surpluses are expected to exceed any such shortfalls and further bolster reserves. Given the scale of the foreign assets, the government's payments capacity should be able to withstand any foreseeable shocks or capital outflows emanating from the otherwise worrisome fiscal situation. In addition, the reserves cushion provides room for a gradual easing of foreign borrowing restrictions and other capital controls.
Moody's also notes the recent moves toward a rapprochement between the Indian and Pakistani political leadership, although the peace process is at an early stage and depends uncomfortably upon the leaders' continuance in office. In the event that the negotiations can meaningfully reduce regional tensions, the potential exists for a reallocation of scarce resources from defense to social welfare programs.
In most emerging market countries, Moody's aligns the country ceiling on foreign currency bank deposits with the government's rating on its local currency debt. Historical experience shows payments problems for these two classes of debt to be closely connected. In India's case, this linkage has been marginally loosened for now, with a negative outlook on the domestic currency debt and a stable outlook on the bank deposit ceiling. This distinction reflects the fact that the banking system's assets and official foreign reserves are substantial compared to non-resident deposits, even though a meaningful portion of the deposits is likely to be withdrawn in the event of a domestic fiscal crisis.
Moody's says that concrete progress on controlling India's fiscal deficit across all levels of government is still desirable in order to stabilize the government's domestic currency rating. Accordingly, the agency will watch for more ambitious implementation of public sector and labor market reforms following the upcoming national elections.
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