India has been languishing at the bottom of the investment grade ladder in the ratings universe. In fact, to put it on record, India has had a net rating upgrade only once in the last 25 years. With conflicting opinions in the Fiscal Responsibility and Budget Management (FRBM) Committee report, we may just have provided an excuse to these ratings agencies, says a research note.
In the report, State Bank of India (SBI) says, "The interesting point is that even in the FRBM committee report there have been conflicting opinions about 60% target of debt to gross domestic product (GDP) ratio. We also second the opinion of the Chief Economic Advisor (CEA) about focusing on primary deficit, rather than targeting multiple indicators to maintain the sustainability of our fiscal position. In the end, we may have just played into the hands of rating agencies who maintain India has a high debt to GDP ratio. The rating agencies wanted an excuse, and we may have unintentionally provided them with one!"
One of the common arguments made by rating agencies for not upgrading India’s rating is India’s high debt to GDP ratio. At 69.5%, the agencies argue that this is on the higher side and effectively acts as an enabling factor of crowding out private investment.
"This argument is however fundamentally flawed, for two reasons," SBI says, adding, "First there are a number of countries which are rated above India but have a significantly higher gross general government debt. In fact, most of these countries have debt positions which have been worsening over time but that has not affected their ratings much, maybe because of other macro fundamentals and the advantage of already being in the developed country bracket. India, on the other hand, has been consistently on the path of reducing its debt to GDP ratio to its present level from a peak of 84% in 2003. The General Government Debt as percentage of GDP was 69.5% for 2016 and if we look at only public debt it amounts to 42% of GDP of which only around 4% is the external debt."
"Second, it is the composition of the Government debt to GDP per se that matters for any discussion on debt solvency. For India, public debt is mostly internal. As a conscious strategy, issuance of external debt (denominated in foreign currency) is kept very low in India. Overseas investors account for only 4% in the total government bonds and the majority of the investment comes from scheduled commercial banks, insurance companies, Reserve Bank of India (RBI) and provident funds accounting for around 85%," it added.
SBI says, it is ironic that Japan which has a composition of domestic debt profile almost similar to India (bank and insurance companies account for 65% of the internal debt), but Japan is rated at A+ with a debt to GDP ratio of 239%.
"Our concern is however, despite robust macro fundamentals, India may not witness a rating upgrade soon. This is because with the FRBM Committee emphasizing on attaining 60% Debt to GDP ratio, by 2023, the rating agencies will get a reason to maintain the status quo, despite the other visible advances which India has made," SBI concluded in the report.