By retaining India's rating S&P has taken a balanced view of the economy

Madan Sabnavis, chief economist, CARE Ratings (Photo: PHOTO CREDIT: Kamlesh Pednekar)
A lot of uncertainty over India’s sovereign rating has been cleared by S&P which has retained the BBB– grade with stable outlook. After Moody’s had lowered India’s rating to a similar level earlier with negative outlook there was debate on how the other agencies would react.

The view taken by S&P appears to be more balanced as it has factored in the challenges and opportunities that the country faces but takes a different view that the economy will regain poise in FY22 and grow by 8.5 per cent after falling by 5 per cent this year. It is certainly more sanguine about the prospects given the strong fundamentals which can help to withstand the Covid-19 impact.

Lets us see the positives that have been highlighted by the rating agency. Three things stand out. First growth prospects appear to be above average post Covid-19 which is realistic. Second, the external situation is very good. Contrary to expectations in FY20 and the shutdown, the forex reserves have been moving upwards towards the $500 billion mark. Quite clearly this has been enabled by both the CAD coming down and an increase in capital inflows especially through the FDI and ECB routes. This has strengthened the balance of payments and made India fundamentally strong on the external account. Third the CRA has been appreciative of the evolving monetary situation where the RBI has been more than proactive ever since the shutdown has been announced to smoothen the flow of funds across sectors and create a meaningful time table.

However, three factors remain in the concern zone. The first is the state of the financial sector. This probably holds for all countries which have been providing room for borrowers through moratorium as well as extension of credit lines. There is concern that this can mount at some point of time if the economy does not perform. While FY21 will not enter the picture, it should be realised that if the economy does not bounce back in FY22 the NPA issue will resurface for sure which has been highlighted by the agency.

The challenge for India really is that while the government has been quite tight fisted in the area of expenditure, it has little control over revenue generation
The second is the labour market. Here there has been a conundrum posed with the migrant issue not yet being resolved as jobs have been lost that are required. Further non-commencement of business also means that there can be a further fall in employment which can be a tricky issue during the recovery phase. Some states have allowed for layoffs which though good for business can have other social implications for the government.

S&P has also highlighted the fiscal stress that lies ahead which is important because in the times of Covid-19 all governments have been more flexible with their targets. The challenge for India really is that while the government has been quite tight fisted in the area of expenditure, it has little control over revenue generation. The economic package is more through the financial system which is a positive for the fiscal numbers. The budget has taken on only relief work and not gone overboard in spending. However, expected sharp fall in revenue will keep the fiscal deficit of the combined government in the double digit zone. The challenge is to get it back on course in FY22.

The message really is that growth in FY22 will be critical for any further rating action and this in turn will guide the health of the financial sector as well as fiscal balances. The government for sure is aware of these issues and would be tackling them appropriately.

The writer is Chief Economist, CARE Ratings
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