Why would a country with a zero sovereign default history over the last two decades and with the status of the fifth largest economy in the world be relegated to an almost junk bond status at BBB-/Baa3? The Economic Survey answered this all-important question in 2017—the fiscal when India had emerged as the fastest growing economy in the world, with a growth rate of 7.6%. It covers the tricky and sensitive issue of sovereign credit ratings this year again, when India, impacted by the pandemic, is expected to record a negative 7.7% growth rate over the fiscal 2020-2021.
So, a 7.8% growth as well as a 7.7% de-growth results in the same credit rating? Seems astounding and confusing. Not quite, if one were to understand what goes into how a country is rated by the ‘big three’ credit rating agencies, Standard & Poor’s Global (S&P), Moody’s and Fitch. Sovereign credit ratings represent, in quantitative terms, the ability of the issuing government to meet its debt obligations. A credit rating of AAA is the highest, while BBB-, the credit rating assigned to India, is the lowest among the investment grade bonds. Ratings below this fall within the ‘speculative’ or ‘junk’ grade.
India’s sovereign credit rating of BBB- then boils down to the following: The Indian government’s probability of default, reflecting both its ability and willingness to repay its debt obligations, is very high. International investors then would be advised to beware of lending to India. This, however, seems completely incongruous with facts pertaining to both our ability and willingness to pay. In order to repay debts denominated in dollars, a country needs to possess both the ability and willingness to repay.
The country’s foreign reserves determine its ability to pay. India’s foreign exchange reserves, as of 15 January 2021, were at $584.24 billion compared to its total external debt, including that of the private sector, at $556.2 billion. Its reserves to debt ratio, which was at 78.4% in 2016-17, rose to 85% in 2019-2020, and appears to have further risen to 105% in 2021. The short-term debt owed by the private sector as a proportion of total forex reserves was 19.1% in September 2020. Further, our forex reserves were sufficient to cover 12 months of imports in 2020, as opposed to 11.1 months in 2016. Clearly, India has done reasonably well in terms of its external sector vulnerability, despite a pandemic.
With regard to willingness to pay, clearly, that India has not had a zero sovereign default history attests to the fact that the probability of default is extremely low. In November 2016, Standard & Poor’s cited low per capita GDP and relatively high fiscal deficit as the reasons why India would not be granted a ratings upgrade for some ‘considerable period’. It is clear that the pandemic and the fiscal stimulus in the recent Union Budget would extend the period considerably.
Notwithstanding India faring well in domains pertaining to ability and willingness to pay, there are areas of concern that Indian policymakers will need to attend to. One such is the general government debt as a percentage of Gross Domestic Product (GDP), which has been rising and is expected to reach 91% of GDP in FY 2021, from a level of 75% of GDP in FY 2020. This is the highest level for India since the data has been made available in 1980. Moreover, such debt is likely to stay at high levels of up to 90% for at least another two years as per estimates. Then there is the issue of income inequality, which is likely to get exacerbated with some of the growth-enhancing policies. Thus, even as India prepares itself for a V-shaped recovery, it may be at the cost of the poor.
The third is the issue of deteriorating fiscal health in the last few years. More than the fiscal deficit, the inability of the government to rein in the revenue deficits as also the primary deficits would pose issues of debt sustainability. The Union Budget 2021-22 places the fiscal deficit of the Central government alone at 9.5% of GDP, while the revenue deficit and primary deficit are at 7.5% and 5.1% respectively. To understand this in perspective, the combined fiscal deficit of the Union and state governments in 2016, when S&P refused an upgrade, was in the area of 6%.
At one level, then, we may dismiss the ratings as ‘noisy, opaque and biased’, not reflective of the fundamentals, as in the Economic Survey. But if it were that easy not to care, we wouldn’t have the topic of sovereign credit ratings rising, phoenix-like, ever so often. And so, while India’s sovereign credit ratings may not indeed reflect its fundamentals, the fundamentals themselves do not merit complacency. In fact, the latter are likely to be affected by the credit ratings going forward. And therein lies the key to the curious case of the salience of India’s sovereign credit ratings!
(Views are personal)
Tulsi Jayakumar (tulsi.jayakumar@spjimr.org)
Professor, Economics and Chairperson, Family Managed Business at Bhavans SPJIMR