International rating agency Moody’s has upgraded India’s local and foreign currency issuer ratings to Baa2 from Baa3 and changed the outlook on the rating to stable from positive. The rating agency has cited the government’s implementation of its reform programme which includes introduction of the Goods and Services Tax, Aadhaar system of biometric accounts and direct benefit transfer schemes and measures taken to address bad loans in the banking system.

The rating upgrade comes after a gap of 13 years – Moody’s had last upgraded India’s rating to ‘Baa3’ in 2004.
The immediate impact of the rating upgrade is that the cost of international borrowing will become cheaper for Indian government and Indian corporates whose ratings are constrained by the sovereign rating. Issuers of lower rated paper have to pay higher rates to make up for the perceived credit risk. The move will also improve the sentiment in the equity markets.

“Moody’s believes that those (reforms) implemented to date will advance the government’s objective of improving the business climate, enhancing productivity, stimulating foreign and domestic investment, and ultimately fostering strong and sustainable growth. The reform program will thus complement the existing shock-absorbance capacity provided by India’s strong growth potential and improving global competitiveness,” the rating agency said in a statement today.

The upgrade comes as a major boost to the Narendra Modi government which has been under fire for the fallout of GST and demonetisation on business. “The decision to upgrade the ratings is underpinned by Moody’s expectation that continued progress on economic and institutional reforms will, over time, enhance India’s high growth potential and its large and stable financing base for government debt, and will likely contribute to a gradual decline in the general government debt burden over the medium term. In the meantime, while India’s high debt burden remains a constraint on the country’s credit profile, Moody’s believes that the reforms put in place have reduced the risk of a sharp increase in debt, even in potential downside scenarios,” said the rating agency in a statement.

Demonetisation which has been facing severe criticism after most of the currency was returned to banks has also been viewed positively by Moody’s. “Government efforts to reduce corruption, formalize economic activity and improve tax collection and administration, including through demonetization and GST, both illustrate and should contribute to the further strengthening of India’s institutions,” the agency said.

On the fiscal front, efforts to improve transparency and accountability, including through adoption of a new Fiscal Responsibility and Budget Management (FRBM) Act, are expected to enhance India’s fiscal policy framework and strengthen policy credibility. The other reforms which have helped in the upgrade are the legislation towards fiscal responsibility and the shift to a monetary policy committee for interest rate setting. “Adoption of a flexible inflation targeting regime and the formation of a Monetary Policy Committee (MPC) have already enhanced the transparency and efficiency of monetary policy in India. Inflation has declined markedly and foreign exchange reserves have increased to all-time highs, creating significant policy buffers to absorb potential shocks,” Moody’s said.