Rating agencies take refuge in FRBM panel report

India has been languishing at the bottom of the investment grade ladder in the ratings universe. In fact, to put it on record, India has had a net rating upgrade only once in the last 25 years.

One of the common arguments made by rating agencies for not upgrading India’s rating is the high debt to GDP (gross domestic product) ratio.

At 69.5 per cent, the agencies argue that this is on the higher side and effectively acts as an enabling factor of crowding out private investment. This argument is, however, fundamentally flawed, for two reasons.

First, there are a number of countries, which are rated above India but have a significantly higher gross general government debt.

In fact, most of these countries have debt positions, which have been worsening over time but that has not affected their ratings much, maybe because of other macro fundamentals and the advantage of already being in the developed country bracket.

India, on the other hand, has been consistently on the path of reducing its debt to GDP ratio to its present level from a peak of 84 per cent in 2003.

The general government debt as per cent of GDP was 69.5 per cent for 2016 and if we look at only public debt it amounts to 42 per cent of GDP of which only around 4 per cent is the external debt.

Second, it is the composition of the government debt to GDP per se that matters for any discussion on debt solvency. For India, public debt is mostly internal.

As a conscious strategy, issuance of external debt (denominated in foreign currency) is kept very low in India. Overseas investors account for only 4 per cent in the total government bonds and the majority of the investment comes from scheduled commercial banks, insurance companies, the Reserve Bank of India (RBI) and provident funds (accounting for around 85 per cent).

It is ironic that Japan, which has a composition of domestic debt profile almost similar to India (bank and insurance companies account for 65 per cent of the internal debt), but Japan is rated at A+ with a debt to GDP ratio of 239 per cent.

Our concern is, however, despite robust macro fundamentals, India may not witness a rating upgrade soon. This is because with the FRBM (fiscal responsibility and budget management) committee emphasising on attaining 60 per cent debt to GDP ratio, by 2023, the rating agencies will get a reason to maintain the status quo, despite the other visible advances that India has made.

The interesting point is that even in the FRBM committee report there have been conflicting opinions about 60 per cent target of debt to GDP ratio. We also second the opinion of the chief economic adviser (CEA) about focusing on primary deficit, rather than targeting multiple indicators to maintain the sustainability of our fiscal position (FRBM review committee report volume I, annex-V).

In the end, we may have just played into the hands of rating agencies who maintain India has a high debt-GDP ratio. The rating agencies wanted an excuse, and we may have unintentionally provided them with one!

(The author is chief economic adviser of the economic research department of the State Bank of India)