The rating upgrade of India's sovereign rating by Moody's has flared up financial markets. But it's not time yet to cheer. Here's why.
1. The other two big global rating agencies place India in the lowest of the investment grade: S&P and Fitch Ratings has assigned India BBB- rating (lowest in the investment grade list). Both leading agency are still to upgrade India S&P hasn't changed its stance for more two years. Similarly, Fitch has maintained its BBB- for quite long time.
2. High government debt to GDP ratio: India has been running a very high government debt to GDP ratio of close to 70 per cent. Over the years, the rising fiscal deficit has increased the government debt, which is not good for an economy as it has to be serviced or government should have enough resources to service high accumulated interest obligation. Our neighboring country China has debt to GDP ratio of 46 per cent. US and UK are at over 70 per cent, but they are developed countries with resources to meet the obligation. In fact, S&P has put a threshold or more as a condition for India to reduce the debt to GDP ratio to below 60 per cent.
3. Possibility of missing the fiscal deficit target: The finance minister Arun Jaitley has hinted a possible relaxation in the fiscal deficit target. As per the road map, the fiscal deficit as a percentage of GDP has to go down from 3.2 per cent in 2017-18 to 3 per cent in 2018-19. Given the structural reforms like GST and banks NPA clean up, and need for high public expenditure, there is every likelihood of some relaxation in the fiscal deficit. This is not something new. India's tread on the path of fiscal consolidation till 2007-08 when the fiscal deficit reached 2.5 per cent level. But post the financial meltdown when stimulus became very necessary, India went back to higher fiscal deficit. It remained at over 4 per cent post 2007-08 till 2014-15.
4. Current account deficit is back: Higher oil prices, which are over $60 a barrel, could easily translate into higher import bill and consequently higher trade deficit if the export doesn't back up. In fact, India runs a trade deficit for many decades. The trade surplus was last seen in 1976-77. A higher trade deficit could put pressure on current account deficit ( CAD). The lower CAD trend has already reversed in the first quarter of 2017-18 when CAD moved from 0.7 per cent in 2016-17 to 2.4 per cent in the first quarter of 2017-18. The country's economy so far was saved because of lower oil prices or imports and sustained inflow of dollar into Indian equity and debt market. But if the CAD widens, there will be implication for Indian rupee value.
5. No respite to Indian banks: The Indian banking industry especially the public sector banks (PSBs), which control more than two third of the banking, are in bad shape. While the government has announced a recapitalization plan, a bulk of the money would get absorbed in NPA provisioning. There is no peaking of NPA numbers. The stress in the banking sector will have implication for the economy. There are already over half a dozen banks that are under the preventive corrective action (PCA) framework of the RBI. There is an urgent need to reform the PSBs so that they can play a long term role in financing the India's capital expenditure needs with disruption in asset quality.