Global rating firm Moody's Investor's Service has said that India's Baa3 government bond rating incorporates the strong growth potential of its large and diverse economy as well as the government's high fiscal deficits and regulatory and infrastructure constraints on competitiveness.
The positive outlook on the rating reflects Moody's view that recent and proposed policies will stabilize inflation, improve the regulatory environment, increase infrastructure investment and lower government debt ratios.
According to the rating agency, policy progress is likely to be slow and unlikely to be reflected in near term economic indicators. However, if policies to improve India's operating environment are effectively implemented, and accompanied by a strengthening of institutions, their impact will improve the sovereign credit profile over the medium term.
The report points out that India's macro- economic indicators have improved over the last few years. The general government deficit and government debt to GDP ratio are both lower than their levels in 2009. In addition, inflation and the current account deficit-to-GDP ratio have also declined from their recent peaks.
Noting that in addition to lower oil prices, tighter fiscal and monetary policies have also helped restore India's macro-economic balance over the last two years, Moody's highlights that this improved balance offers the Indian economy and financial system some resilience to potential volatility in global capital flows in coming months.
Although it has slowed from peaks achieved a decade ago, India's GDP growth - which Moody's forecasts at 7 per cent this year - is likely to surpass the average for its peers, as it has over the last decade. As a commodity importer, India benefits from a low commodity price environment, and its reliance on domestic demand for GDP growth shields the economy somewhat from the subdued outlook for global growth.
The report says that India's rating could be upgraded if Moody's expectations of gradual but credit positive reforms are realized in actual policy implementation and if the recent improvement in inflation, fiscal and current account ratios is sustained.
However, the rating outlook would likely return to stable if there is a reversal of the policy reform process; if banking system metrics continue to weaken; or, if there is a decline in foreign exchange reserves coverage of external debt and imports.