Why Moody’s has a Baa3 Sovereign rating for India. Surely it is time to upgrade India’s Sovereign rating from Baa3 to at least A3, if not more, the same that China enjoys because of plenty of reasons
Dear Marie Diron
Senior VP, Sovereign Risk Group, Moody’s Investors Service
I have followed your work at Moody’s closely and, needless to add, have been thoroughly impressed with the sheer detailing that goes into every pronouncement that you make, among other things. This letter from my end is to share with you my concerns on why Moody’s has a Baa3 Sovereign rating for India. Surely, it is time to upgrade India’s Sovereign rating from Baa3 to at least A3, if not more, the same that China enjoys. The reasons for this overdue upgrade are many but the more specific ones to start with, to which I wish to draw your kind attention, are the following:
India’s huge future GDP growth trajectory
In the last two fiscal years, India has clocked a real GDP growth of 7.2 per cent and 7.6 per cent, notwithstanding two failed monsoons with agricultural growth grinding to a negative 0.2 per cent in 2014-15 and just 1.1 per cent in 2015-16. With normal monsoons this year, foodgrain production which has been stagnant at about 252 million tonnes in the last two years, is slated to come in at 272 million tonnes in 2016-17, as per initial estimates, which would be an all-time record in India’s post-Independent history, higher than the previous high of 265 million tonnes. Also, now that GST will become a pleasant reality in 2017, thanks to the dogged perseverance of Arun Jaitley, India’s dynamic Finance Minister, it should add 1 to 2 per cent to India’s GDP in the medium term. The stage is set to aspire for and achieve a sustainable GDP growth of 8 to 10 per cent and more in the decade ahead. A high rate of economic growth increases a country’s ability to service its debt burden, over a period of time, thereby improving its solvency. China and India are the 2nd and 9th largest countries of the world, in terms of nominal GDP. On PPP basis, China was at 1st and India at 3rd place in 2014. Both countries together share 16.08 per cent and 23.16 per cent of total global wealth in nominal and PPP terms, respectively. However, the moot point to be noted is, China’s best is behind it while India’s best is yet to come! Between 1980 and 2013, average real GDP growth in China was 9.8 per cent and India’s 6.23 per cent. That is set to reverse dramatically, starting now. In the next 10 years, the Chinese juggernaut is slated to crawl at between 6 and 7 per cent, maybe far lower, in real terms, as noted by prominent economist, Cai Fang. last year China’s real GDP grew at 6.9 per cent, the slowest ever in 25 years, while in nominal terms, the growth was even lower, at just 6.2 per cent. India’s nominal GDP growth, on the other hand, should be in the region of 11-14 per cent in 2016-17.
China has the fastest growing old-age population globally, says the World Bank. That indeed is its “Achilles heel”, by far. last year, the Chinese labour force shrank by 4.87 million people. It is said, by 2050, more than 40 per cent of China will be more than 60 years old and the number of “Old Chinese” will be larger than the combined populations of Germany, Japan, France and Britain! With an average life expectancy of 76 years, the demographic upheaval is sure to result in both socio-political and economic unrest in the land of the Dragon. What is not helping matters is the fact that more than 85 per cent of China’s exports are produced by coastal China but surprisingly, coastal China is among its poorest regions, with most of the wealth being concentrated in the inland provinces. In sharp contrast, more than 65 per cent of India is 35 years old or lower and more than 50 per cent of India is 25 years old or lower. Again, where India scores over China is employment. China’s unemployment rate is 4.1 and India’s 4.2 per cent. However, the Chinese figure of 4.1 per cent that hides more than it reveals, computed by its National Bureau of Statistics, has been trashed by its Urban Health Survey that pegs the unemployment rate at more than 10 per cent! likes of Fathom Consulting in fact, say, China’s unemployment rate is a whopping 12.9 per cent!
Fiscal Balance
India’s fiscal deficit stood at 4.5 per cent and 4 per cent in 2013-14 and 2014-15. However, in 2015-16, the fiscal deficit was reined in at 3.9 per cent of GDP; for the first time at sub 4 per cent in seven years. What is even more commendable is the fact that the fiscal gap was reduced without curtailing plan expenditure. In 2016-17, fiscal deficit target has been retained at 3.5 per cent and again this, despite increasing plan expenditure allocation by 15.3 per cent. The additional fiscal space to the Modi Government comes from the slew of subsidy reforms that have been undertaken. Subsidies have reduced from 2.1 per cent of the GDP in 2014-15 to 1.9 per cent in 2015-16, with that number slated to go down to just 1.7 per cent in 2016-17, thanks to Direct Benefit Transfer, which has already transferred subsidies worth more than Rs 62,000 crore to the accounts of more than 2 lakh beneficiaries. The fact that revenue deficit in 2015-16 stood at just 2.5 per cent versus Government’s target of 2.8 per cent of the GDP is again a reflection of the vast improvement in quality of public spending, which deserves kudos. In 2016-17, the Government has earmarked about Rs 48,000 crore for agriculture and irrigation and a sizeable Rs 2.21 lakh crore for rail and roads, of which Rs 97,000 crore will be spent on roads alone. These numbers prove beyond doubt the Modi-led Government’s intent to ensure growth remains the foremost agenda, without compromising on fiscal prudence.
Coming back to China, its national fiscal expenditure growth rose significantly by 15.8 per cent in 2015 from 8.3 per cent in 2014, while national fiscal revenue growth slowed to 8.4 per cent from 8.6 per cent, resulting in a headline fiscal deficit of 3.5 per cent of the GDP. That’s up from 2.1 per cent deficit in 2014. This, despite Government-funded infrastructure investment declining to 17 per cent in 2015 from 19.9 per cent in 2014. Interestingly, the IMF recently estimated that the real fiscal deficit in China averaged around 10 per cent of the GDP, due to leveraged SOEs (State-owned enterprises). This fiscal deficit suggests the Chinese Government is not shy about launching a mindless “pump-priming” exercise to offset slowing growth from structural headwinds, adding to the problems.
Inflation
Average Wholesale Price Inflation (WPI) that was 7.4 per cent in 2012-13 in India, averaged just 2 per cent in 2014-15. After being in a negative zone since November 2014, WPI came in at a positive 1.62 per cent in June 2016, signifying pick-up in demand and purchasing power and more importantly, return of pricing power in the hands of manufacturers. However, it is not WPI but Consumer Price Inflation (CPI) or retail inflation that is the key variable to watch out for, argue Modi’s critics. Well, average CPI that was 10.2 per cent in 2012-13, hit a high of 11.16 per cent in November 2013 under a corrupt Congress-led UPA, before falling to an average of just 5.9 per cent in 2014-15, with a new low of 3.69 per cent in July 2015, under the Modi-led Government. Every 5 per cent rise in pulses inflation adds 12bps to CPI and the recent surge in CPI at 5.76 per cent and 5.77 per cent in May and June 2016 is primarily due to pulses inflation that has been hovering at close to 30 per cent. However, a 40 per cent rise in area sown under pulses this year should sharply bring down pulses inflation, which should in turn help the Government stick to its retail inflation target of 5 per cent by March 2017. In fact, formal inflation targetting of 4 per cent by 2021, with a 2 per cent margin on either side, is a radically bold step by the BJP-led NDA Government in ensuring a lower inflationary path going forward, that augurs well for India, as it is credit positive. And yes, for those who say inflation under Modi Government is down only thanks to lower crude oil prices globally, let me point out, “fuel and power” as a category only has a 14.91 per cent weightage in WPI. In CPI, “fuel and light”, has a weightage that is even lower, at just 6.84 per cent! The truth of the matter is inflation is down in the last two years primarily due to the Government’s efforts in removing various supply bottlenecks, including carrying out APMC reforms.
Speaking of China, CPI between July 2015 and July 2016 averaged at 2 per cent, versus Government’s target of 3 per cent and that is not good news as it hides disinflationary trends. Also, PPI, Producer Price Index, for instance, has been contracting since March 2012 and in July 2016, it fell by 1.7 per cent; this, after a 2.6 per cent fall in June 2016. Excess of anything is bad. Hyper-inflation is a tax on the poor. Equally, a deflationary spiral that China is currently experiencing in terms of producer prices could be even worse as businesses are being forced to absorb costs and compromise profit, just to get their products moving. China is facing a double whammy, with parts of the economy facing disinflation and other parts, deflation. That can be a devastating mix, if not nipped in the bud. Simply printing more money that PBOC is notoriously infamous for may make matters worse by raising inflation without raising growth. China clearly has more problems in its hands, stuck between a rock and a hard place!
External balance
India’s rapid progress on the external front is best captured by the CAD (Current Account Deficit) data. CAD which was 4.8 per cent of the GDP in 2012-13 under an inept Congress-led UPA was down to 1.3 per cent in 2014-15 and even lower at just 1.1 per cent in 2015-16. While CAD is likely to inch up to 1.6 per cent of the GDP in 2016-17, on the back of higher domestic demand fuelled by a good monsoon, Seventh Pay Commission recommendations and higher capex spending by the Government, among other things, what is clear is, CAD will be reined in at sub 2 per cent of GDP in the medium term, driven by a healthy Balance of payments on the back of a lower trade deficit. For instance, trade deficit that was $145bn in 2014-15 fell to $130bn in 2015-16. While a lower trade deficit is partly due to a fall in imports, thanks to weakness in global trade, one cannot underestimate the fact that India’s trade deficit has come down sharply, among other things, due to a sharp fall in frivolous gold imports and that is laudable. Besides CAD, India scores very well on another vital parameter... External debt is just 23.6 per cent of the GDP. More importantly, short-term debt as a portion of overall external debt is just 17 per cent, well below the 24 per cent in 2013. Short-term debt as a portion of forex reserves too is down from 33 per cent in 2013 to just 24.8 per cent now. Meanwhile, India’s total debt to the GDP ratio remains at a very reasonable 67 per cent, giving it the much-needed cushion for policy manoeuvres, if need arises.
In sharp contrast, China is sitting on a ticking time bomb with total debt to the GDP ratio having snowballed from 160 per cent in 2007 to 282 per cent in 2014-15. In the said period, China has added more than 21 trillion dollars to its burgeoning debt pile. If it continues to add debt at the same rate, by 2018, China’s total debt to the GDP ratio could be a dangerous 400 per cent! To compound matters, more than 70 per cent of China’s external debt is short-term in nature. Also, with more than 50 per cent of China’s external debt being Renmimbi, RMB denominated, any depreciation against the dollar could be fatal, leading to massive capital flight, as was witnessed in August 2015. Spread between onshore and offshore RMB widened to 1,100 bps in January 2016 and that is a story in itself, suggesting that huge capital outflows at quick intervals, will be the norm rather than the exception for China, going forward. Unfortunately, China is running out of choices. Sudden and sharp exchange rate depreciation will lead to capital flight, while exchange rate depreciation may actually, just be the tonic that its exporters crave for at this stage, what with exports falling by 7 per cent in dollar terms both in 2015 and in the first five months of 2016. What a mighty fall for a country which had an average export growth in excess of 25 per cent, prior to the lehman crisis of 2008!
I know Moody’s recently raised India’s outlook from “stable” to “positive” and downgraded China’s outlook from “stable” to “negative”. Ms Diron, as a corollary to that, I would sincerely urge you and your team at Moody’s to upgrade India’s Sovereign rating too, from Baa3 to A3, more so, given the policy push and reforms that have been unleashed on a war footing by India’s visionary Prime Minister Modi, in the last two years. Be it the Aadhar Bill aimed at financial inclusion, the Bankruptcy code Bill that will purge banks of bad loans by fixing culpability and accountability, or the GST Bill that will eradicate supply-chain inefficiencies, India has come a long way from that scary moment in 1990-91, when saddled with forex reserves of just 1.2 billion dollars, it had to pledge 67 metric tonnes of gold with the IMF, to raise a mere 600 million dollars. Today, with forex reserves of about 365 billion dollars and more than 20,000 tonnes of idle gold that is greater than the combined gold reserves of the IMF, Germany, the USA and Switzerland, India stands for solvency, credibility, stability and much more.
(The writer is an economist, Stock market expert & spokesperson for the Mumbai BJP. Views are personal. Verma can be reached on sanjuvverma@yahoo.com)