Date: 13/05/2023

Relevance: GS-3: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development, and Employment.

Key Phrases: foreign direct investment (FDI), sovereign rating of Fitch, BBB-, Credit Rating for Sovereigns, digitization, Strong forex situation, Improved quality of government spending, Fiscal Stimulus, Role of RBI.

Why in News?

• India is one of the largest recipients of foreign direct investment (FDI) and foreign portfolio investment (FPI), with a high level of foreign investors' confidence.
• However, global credit rating agencies seem to have a fixed mindset when it comes to evaluating India's economic structure.
• The sovereign rating of Fitch has been maintained at BBB-, just above investment grade, indicating an anomaly.

Credit Rating for Sovereigns vs. Companies

• The concept of credit rating for sovereigns is different from that for companies.
• While the agency evaluates the probability of default for companies based on their performance parameters, for sovereigns, the overall economic structure of the country is evaluated to gauge whether it can default.
• The evaluation of a country's creditworthiness is subjective as countries can always print currency to repay their debt, even at the risk of high inflation.
• This is a risk that credit rating agencies must consider while evaluating a sovereign's creditworthiness.

Is this evaluation justified for India?

• Such an evaluation can be justified if countries have external exposure.
• However, for India, almost all debt is exclusively in rupees and even participation of FPIs is in rupee bonds.
• Therefore, there is never a case of forex risk for India. And the ultimate vindication of any country’s credibility is how investors perceive the economy.
• Therefore, if foreign investors are bullish on India, a rating of just investment grade seems an anomaly.
• These are investors who are actually putting their money on the table and have never had any issue in taking it out, as there is full capital account convertibility there.

Compelling Reasons for a Rating Upgrade:

• Impressive Growth Numbers:
  • Without making comparisons with other nations, the growth of 7 percent in FY23 and 6-6.5 percent projected for FY24 is quite impressive.
  • While it is lower than the potential of 8-8.5 percent, coming out of the Covid blow, the performance is more than commendable.
• Nuanced Approach to Fiscal Stimulus:
  • During the lockdown, India's approach to fiscal stimulus was unique compared to other nations.
  • Revenue was pushed back, while expenditure was nuanced through reform and policy measures.
  • Using banking channels to provide support helped the industry, while guarantee schemes provided assurance to the financial system.
  • There is a determination to revert to the path of fiscal prudence in a minimal time period.
  • Expenditure is being rolled back, such as the free food scheme being amalgamated with the food subsidy.
• Banking System Rebound:
  • The Indian banking system has rebounded well and used the pandemic period to clean up the books.
  • This puts the banking system in a better position to provide funding and enable the economy to move onto a higher growth path.

RBI’s role:

• Smooth Withdrawal of Accommodation:
  • The RBI has ensured a smoother path to normalcy compared with the central banks of other nations.
  • Here the withdrawal of accommodation has worked well and has been done in a non-obtrusive manner.
  • Also, here interest rates have moved without any significant impact on growth. This is important because the kind of volatility that has been witnessed in the US on account of the Fed raising interest rates, has not been seen in India as bond yields have moved in a narrower band.
• Strong forex situation:
  • The RBI has ensured a couple of things:
    • First, as the dollar appreciated, the rupee always remained at the median level of depreciation compared with other currencies, which ensured there was no market panic while retaining the competitive edge for exporters.
    • Second, forex reserves, which declined mainly due to valuation issues, have regained their level subsequently with a comfortable import cover ratio of just above nine months. This provides a lot of support to the balance of payments.
• Improved quality of government spending:
  • The Budget has increased the share of capex from around 12-13 percent pre-pandemic to 22 percent for FY24.
  • Despite the number of upcoming Assembly elections this year, the Budget has plumped for fiscal prudence.
• New trade agreements:
  • An important development during the year was the way in which India was able to initiate new thinking on the trade front, as seen in the rupee trade agreement with Russia which has now found favour with several countries.
  • This is a major step as these arrangements can help countries move away from the dollar-euro dependence which will add to their economic strength.
  • While admittedly this is a slow process and will take time to work out, the strategy to go domestic is a unique model.
  • This needs to be appreciated by the rating agencies as it is a model that several emerging countries will find worth pursuing.
• Digitization:
  • India’s strides in digitization have been remarkable, spanning from banking transactions to the Covid vaccination drive.
  • The digitization drive has brought about structural changes in the economy making systems more efficient.

Conclusion:

• Global credit rating agencies need to reinvent themselves to retain their credibility, revisiting old shibboleths.
• India certainly deserves a fair and unbiased evaluation, with its unique model of going domestic.
• The rating methodologies need to adapt to the changing times, as old mindsets hinder the rating agencies' credibility.
• The commentary given about India is usually positive, and the low rating awarded is unjustified.
• It is time for the rating agencies to acknowledge India's robust economic performance, giving it the rating, it deserves.

Source: The Hindu BL

Mains Question:

Q. Credit rating agencies have been criticized for their unfair evaluation of India's sovereign rating. Discuss the factors that justify a higher rating for India and the need for credit rating agencies to adapt their methodologies to changing times.