Reforms to boost growth; banking risks constraint rating: Moody's

It estimated that the fiscal costs of equity injections in public sector banks are manageable

Moody's Investors Service on Tuesday said the reforms undertaken by the Centre will help boost investor confidence and bolster growth potential, but cautioned that muted private investment and banking sector risks will remain a constraint on India's sovereign rating.

It also said in the near-term challenging budget targets could lead to significant spending cuts late in the year, especially since fiscal deficit till July had touched 74 per cent of the whole year's budget target.

"In Moody's view, over time, the multi-pronged but step- wise approach to reform will foster a stable macroeconomic environment. In particular, the cementing of the monetary policy framework with the objective of maintaining inflation at moderate levels is credit positive. Moody's expects continuity in monetary policy, which is a credit positive," said Moody's Sovereign Group Senior vice president Marie Diron.

Moreover, structural hurdles will continue to constrain private sector investment and growth and banking sector will continue to pose contingent liability risks to the government over the near to medium term, Moody's said.

"The credit implications of India's reforms will materialise in the medium term," it said.

Moody's points out that banking sector risk will also remain a constraint on India's sovereign ratings.

While bad asset recognition is a first step, the measure does not strengthen the resilience of banks, and therefore does not reduce the contingent liability risks for the sovereign.

Moody's estimated that the fiscal costs of equity injections in public sector banks are manageable, although they are larger than currently budgeted and will add to the government's challenge in meeting its fiscal targets.

Speaking at a joint Moody's-ICRA sovereign and macroeconomy briefing in New Delhi, ICRA Senior Economist Aditi Nayar said economic growth will pick up in financial year (FY) 2016-17 to 7.9 per cent, from 7.6 per cent from the FY.

In the near-term, Moody's expect private investment will remain weak as corporates in investment-intensive sectors are burdened by elevated debt levels.

In addition, the economy will remain vulnerable to fluctuations in monsoon rains. In general, infrastructure gaps will continue to constrain investment and the rise in foreign direct investment (FDI) will not make up for muted domestic investment, it cautioned.

In terms of the monetary policy framework, the government of India has notified a Consumer Price Index (CPI) inflation target of 4 per cent, within a tolerance band of 2-6 per cent until March 2021.

"Such a scenario would help to anchor inflationary expectations. In addition, a favourable base effect as well as improved crop sowing dynamics will ensure that CPI inflation remains within this tolerance band in the near term," ICRA said.

However, higher global food prices and the anticipated improvement in domestic demand — after the implementation of revised scales for the Central Government employees and pensioners — pose modest risks to the inflation trajectory.

"Without taking into account the impact of the eventual increase in allowances — based on the recommendations of the Seventh Central Pay Commission, because the timing of the implementation is unclear — ICRA expects that CPI inflation will record a mild hardening to about 5.1 per cent in FY2017 from 4.9 per cent in FY2016," it said.

Moody's further said that a few fiscal measures entail some, although limited, immediate savings for the government, including through subsidy reform and more moderate increases in Minimum Support Prices (MSP) than in the past.

"The implementation of the goods and services tax  — which Moody's assumes will become effective in 2017 — will enhance revenue collection for the government over time, through better tax compliance and higher profits, as businesses save on tax administration costs," it said.

Moody's further said that some reform measures, if effectively implemented, will bolster India's growth potential.

Easing of restrictions on FDI could foster productivity growth in some sectors; the bankruptcy law, which, if credible, would enhance investor confidence; besides measures like improved access to bank accounts and those aimed at easing business starts.

However, these reforms will ease rather than remove some of the hurdles to robust and sustained investment, and therefore growth in India, Moody's said.

The staggered implementation of pay revisions by the Central Government and a number of State Governments, as well as the improved outlook for the rural economy post-monsoon, portend that consumption will continue to drive economic growth in FY2017.

However, fiscal constraints will limit the space available for direct infrastructure investment by the Central Government in FY2017. In addition, the mixed global growth outlook will prevent merchandise exports from emerging as a major growth driver in the near term, Moody's said.

India's sovereign rating by Moody's stands at Baa3, the lowest investment grade — just a notch above junk status.