No, India not strong enough yet: S&P's status quo cools Moody's upgrade

Standard & Poor’s stuck with its “BBB-minus” sovereign rating and “stable” outlook for India on Friday, declining to follow Moody’s recent decision to upgrade the country’s rating, citing low income levels, high debt and weaker government finances. Moody’s Investors Services had a week ago upgraded India’s credit rating to “Baa2” from “Baa3”, one notch higher than S&P’s current rating, citing progress on economic and institutional reforms would lift the country’s growth potential. This author discusses whether India has grown strong enough to have crossed the debt burden.

In what could be considered as a less enthusiastic view on India’s debt sustainability, Standard & Poor’s (S&P) kept India’s sovereign rating unchanged at BBB-, evoking rather ambivalent reactions compared to those that followed the rating upgrade by Moody’s to Baa2 from Baa3 on Nov 16, 2017. The difference in assessment of the two rating agencies is stark.
 

But first let’s look at the similarities. Both the agencies foresee stronger GDP growth of 7.5-7.6% over the forecast horizon of next few years. The slowdown to 6.5-6.6% caused by demonetization and GST implementation led disruptions is seen as short-term disturbances, beyond which growth is expected to rebound.

The key difference is the optimistic view taken by Moody’s on debt sustainability. This is notwithstanding its expectation of a rise of 1% in the ratio in view of the slowdown caused by near-term domestic shocks.
 

In contrast,  S&P is concerned about sovereign debt sustainability of both central as well as state governments. In particular, the agency foresees a fiscal situation of the state governments worsening, i.e. likely addition of 3% on average to the consolidated general government deficit over the forecast horizon till 2020.

The less optimistic picture painted by S&P, especially pertaining to the persistently high deficit at state levels, large general public debt and overall weak public finances are sharply divergent to the declining debt/GDP trajectory projected by Moody’s.
 

The key question to answer is: whether India has grown strong enough to have crossed the hump of debt burden? The evidence is less convincing.
 

Does it not look paradoxical that India’s productive private sector continues to flounder on debt repayment despite the economy estimated to be growing at over 7% (FY15-18), reflected in non-performing loans (NPAs) rising in excess of 40% during the times of high GDP growth? A weak corporate performance is evident from the fact that corporate profits have hardly grown over the past four years.
 

Debt repayment capability of the general government cannot be detached from the broader economic performance, especially the more productive components such as private sector and banks, farm economy etc. All these are currently facing heightened debt sustainability problems.
 

The impaired assets of the public sector banks (PSBs) is currently estimated at around Rs10 trillion( Rs 10 lakh crore) , including around Rs7 trillion ( Rs 7 lakh crore) of gross non-performing loans (GNPAs). Likewise, the corporate balance sheets are still quite leveraged. Together, they constitute the twin balance-sheet problem hampering a faster recovery in economic growth.
 

The avalanche of farm sector loan waivers estimated at Rs2.2-2.7tn, stress in the MSME sector and weak corporate earnings growth reflect the decline in productivity across these sectors. For instance, the farm sector has been facing declining terms of trade by 7% since 2012, indicating weaker price realizations relative to the cost of cultivation. The negative shocks caused by demonetisation worsened the net income for the farm sector, translating into greater farm loan defaults.
 

For non-finance corporates, return on gross fixed assets have declined to a historically low level of 5-6% (FY15-16) from a peak of 22% notched in FY07-08. The return on assets (RoA) for Nifty 50 companies have declined to a low of just 2.5% compared to the peak of  7% recorded in 2007. All these indicate declining productivity of capital along with elevated debt-equity (DE) ratio.
 

Policy responses like the bank recapitalisation at the central government level, farm loan waivers by state governments and conversion of loans of electricity boards into state loans are in-principal nationalisation of failed private debt. Given that we are still at the beginning of the thawing process of private sector debt, requiring more fiscal responses (both by way of fiscal stimulus and direct absorption of private bad debt), there is a significant probability of public debt/GDP ratio rising in the foreseeable future.
 

Moody’s rating upgrade action hinges on the conclusion of some of the pending reforms. While there is some merit in taking a long-term positive view of these developments, the fact that India has been on a perpetual reform path, these reforms may not be the sufficient basis to take a pre-emptive positive view of declining public debt/GDP ratio, especially when based on its own assessment Moody’s is projecting the ratio to rise further during its forecast horizon.
 

In addition, it appears that a cyclical rise in real GDP growth to 7.5-7.6%, projected by these rating agencies, may also not be sufficient for such an optimistic projection given that the debt and fiscal sustainability concerns have been on the rise in the recent past even amid higher average real GDP growth of 7.8% during FY15-FY17.
 

Clearly, S&P’s position, taking cognizance of the still vulnerable fiscal scenario, appears more realistic than Moody’s optimism. My assessment of the broader economy, including the twin balance sheet problems, corporate profitability, employment scenario and farm sector vulnerability outlines pervasive debt sustainability issues. Therefore, the compulsions of committing greater fiscal support, before a sustainable growth cycle gets re-established, is far greater today than before.

Dhananjay Sinha is the Head of institutional research, economist and strategist at Emkay Global Financial Services