Thursday, May 25, 2017

Government of India's credit rating

Moody's rates the Government of India at Baa3.  This is the lowest investment grade rating. Per Ashwath Damodaran at NYU this translates into a country risk premium of 3.13% (I suppose this means that the Government of India would pay interest on loans at 3.13% above the risk-free interest rate.)  The credit rating a notch above Baa3 is Baa2, and countries with that rating have a risk premium of 2.71%.

India's debt to GDP ratio in 2016 was 69.5%.  If India's credit rating improved from Baa3 to Baa2, and if all this debt could be refinanced at the lower interest rate,  the Government of India would save 0.3% of GDP in interest payments, that is about USD $6 billion a year.  Nothing to sneeze at.

Despite India's decent economic performance, Moody's chose not to upgrade India's credit rating (this from December 2016). 

The decision to maintain a positive outlook on the Baa3 rating rather than assigning a stable outlook to the rating at either Baa3 or Baa2 reflects two drivers:

- Economic and institutional reforms introduced since the positive outlook was assigned, and potentially forthcoming, continue to offer a reasonable expectation that India's growth will outperform that of its peers over the medium term and that further improvements in its macro-economic and institutional profile will be achieved.

- However, the reform effort to date has not yet achieved the conditions that would support an upgrade to Baa2, in particular in accelerating private investment to support high, stable growth, without which the government's debt burden -- a key constraint on the rating -- is likely to remain high for a sustained period.
Among the factors constraining the credit rating:
Meanwhile, on the revenue side, India's large low-income population limits the government's tax revenue base. At 20.9% of GDP in 2015, general government revenues were markedly lower than the 27.1% median for Baa-rated sovereigns. Although the implementation of GST and other measures aimed at enhancing income declarations and tax collection will help widen and boost revenues, the effects will only materialize over time and their magnitude is uncertain so far. 
I imagine the "other measures aimed at enhancing income declarations" include demonetization. 

A better credit rating would serve to attract more investment to India.  Widening the tax net in India and improving government finances is a high-stakes game.