For India, year 2024 began on a sombre note with Fitch, a well-known credit rating agency, assigning the country a sovereign credit rating of 'BBB-' with a stable outlook. This rating, technically termed the long-term foreign-currency issuer default rating, holds significant weight as it is an evaluation of a country's creditworthiness by independent entities such as Fitch, Moody’s, and S&P. While BBB- is categorised as ‘investment grade’, standing just a notch above BB+, which is junk bond status, the rating elicited surprise, disappointment and even ire across various sectors given India’s robust growth trajectory and its distinction as one of the fastest-growing nations.
High sovereign credit ratings go beyond merely massaging a country's ego. They serve as indicators of investor confidence, offering insights into the risks associated with investing in a country’s debt, thereby signaling whether to pour more money or withdraw. These ratings also play a pivotal role in attracting foreign direct investment. The credit risk associated with such ratings reflects the likelihood of a government defaulting on its debt in the future. Consequently, poor credit ratings not only elevate the cost of external borrowings for the government, but also render it increasingly challenging for private corporations to secure debt at favorable rates. Thus, while adopting a facade of confidence might seem acceptable, India must confront an array of macroeconomic, structural and political challenges to ascend the credit rating ladder .
India’s GDP growth, estimated at 7.3 percent in 2023-24, remains contingent upon the government’s capital expenditure. This dependence poses the risk of increasing the fiscal deficit, which stood alarmingly high at 9.2 percent (general government deficit) in 2022-23. Addressing it demands either curbing spending, especially on capital expenditures, or resorting to alternative revenue-generating mechanisms.
Revitalising private investments, which remains feeble, as shown by the dwindling gross domestic investment rates and sluggish growth of the Index of Industrial Production or IIP, needs attention. Despite the IIP’s average growth soaring from a paltry 4 percent between 2014-15 and 2018-19 to 11.4 percent in 2021-22 due to a weak base effect caused by the pandemic, it plummeted to 5 percent in 2022-23. The gross domestic investment rate, too, fell from 33.1 percent over 2014-15 to 31.4 percent in 2021-22.
Inflation persisted at elevated levels throughout 2022-23, with core inflation receding from 6 percent in late 2022 to 3.7percent in December 2023. However, headline inflation remained volatile, consistently breaching the psychologically safe upper threshold of 6 percent throughout 2022-23. This has eroded purchasing power, diminishing the share of consumption expenditure from 61.1 percent in 2021-22 to 60.9 percent in 2023-24, further imperiling gross domestic savings and private investments.
The impending elections pose a monumental challenge, despite robust revenue collections, as state governments vie to dispense largesse to constituents. The resultant surge in deficits and debt ratios vis-à-vis India’s peer nations pose a formidable obstacle to improving credit ratings, because the latter are based on such comparisons. Moreover, high interest payments relative to the government’s overall expenditure, due to such high deficits, leave scant fiscal space for stabilising the economy through increased spending and deficits in case of an economic downturn.
Another pivotal challenge lies in the country’s trade dynamics and external sector vulnerabilities. Despite India’s ambitious efforts to enhance its export competitiveness and diversify trade relationships, the trade deficit continues to be a matter of concern. The persistent trade imbalance, coupled with vulnerabilities such as currency depreciation risks and reliance on volatile capital flows, pose challenges to sustaining a favourable credit rating trajectory.
Structural issues such as labour market weaknesses hinder India's prospects of securing a credit rating upgrade. Despite GDP growth, organised formal labour remains stagnant, coupled with a low and declining female labour participation rates and deteriorating employment quality.
India needs to address structural issues such as institutional bottlenecks and regulatory impediments that can hinder business expansion and innovation. Inadequate infrastructure, red tape and regulatory inconsistencies often impede the ease of doing business and deter foreign investors from committing long-term capital. Streamlining regulatory frameworks, enhancing infrastructure investment, and fostering a conducive business environment are imperative to catalyse private sector-led growth and fortify India's creditworthiness.
India must also address its environment, sustainability and governance indicators, which wield significant influence in credit ratings. Two areas will need attention. One, the political stability and rights, where India's percentile rank as per Fitch Ratings falls below 50, and secondly, the human rights and political freedoms under the voice and accountability pillar of the World Bank governance Indicators, where India’s percentile rank is again below 50. Both these indicators are likely to weigh particularly heavily on the credit profile, underscoring the need for improvement in these areas.
India will also need to adopt proactive measures to mitigate environmental risks and promote sustainable development practices. Enhancing renewable energy infrastructure, implementing stringent environmental regulations and fostering green innovation are imperative.
We may well treat the BBB- credit rating as a Western conspiracy designed to keep a growing India down. Alternatively, we could see it as an opportunity to fix certain deep-rooted structural and macroeconomic problems that would make India more resilient, and go beyond inspiring the confidence of rating agencies and investors. The choice is ours.
Tulsi Jayakumar
Professor, finance & economics, and Executive Director, Centre for Family Business & Entrepreneurship at Bhavan’s SPJIMR