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Moody's Changes Outlook on India's Domestic Currency Debt to Stable from Negative as Debt Ratios Stabilize

Moody's Investors Service on 4th May 2006, has changed the outlook on the Government of India's Ba2 domestic currency debt rating to stable from negative, citing the recent stabilization of the government's debt ratios.

The outlook on the country's Baa3 country ceiling for foreign currency debt, the Ba2 country ceiling for foreign currency bank deposits, and the government's foreign currency issuer rating had already been stable, and remain so. The local currency guideline is Aa3 and the local currency deposit ceiling is A1.

In spite of the upward change in the outlook, Moody's said that all of India's fiscal indicators remain at extremely high levels relative to the country's local currency rating peers. Such divergence is tolerated in India's case because of the particular characteristics of the public debt composition, which is overwhelmingly held by domestic residents and subject to strict capital controls. The main explanation for the shift in the trajectory of the debt ratios after many years of deterioration is the combination of robust nominal GDP growth and the cost savings achieved as lower interest rates mitigated the costs of servicing an ever-higher debt. These factors are likely to keep the public debt high, but at worst the trend is likely to flatten out even in the absence of reinforcing structural adjustment.

The rating agency also pointed to specific policy measures that have contributed to the recent fiscal improvement, including an expansion of the tax net that has been accomplished through a series of reforms over more than a decade. Income tax and import tariff rate reductions have led to greater compliance. The coming year's budget involved more changes in this vein across the tax spectrum. Also potentially important is the renewed commitment of policymakers to the Fiscal Responsibility and Budget Management Act with its target of reducing the central government's gross fiscal deficit to 3% of GDP by 2008/09, after famously invoking a "pause" in fiscal tightening last year.

Finally, Moody's indicated that the implementation of the unified value-added tax in nearly all of the country's states and territories has kindled expectations of a significant narrowing of the states' consolidated fiscal deficit starting as early as in 2005/06, which ended in March. This reform follows restructuring of 18 states' debts owed to the central government in recent years as a reward for their own fiscal responsibility legislation and fresh attention to spending restraint and cost recovery.

Moody's acknowledges that noisy coalition politics will continue to present challenges for fiscal consolidation as well as progress on structural economic reform. The liberalization of the financial system and capital controls now being discussed is likely to further complicate, and potentially exacerbate, the transmission mechanisms from the domestic fiscal imbalances to the external sector, which is already registering growing deficits. The rating agency is also mindful of the constraints imposed by social and physical infrastructure shortages but believes that key decisionmakers have increasingly recognized that the necessary fiscal flexibility to address these shortfalls requires a reduced public debt burden and a welcome environment for private investment. Accordingly, an ongoing improvement in India's fiscal credit metrics is expected to proceed, although occasionally at an awkward pace.


Note- The revision in S&P’s India outlook came 14 months after it upgraded the country’s foreign currency rating to BB+ from BB. Moody’s had, in January 2004, upgraded India’s foreign currency rating in two important categories from ‘speculative’ to ‘investment’ grade.

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