China’s pain, India’s gain

Sanjiv Chainani
Mr. Sanjiv Chainani is the Managing Director of Value Line Advisors Pvt Ltd.

India’s rating upgrade could drive a fresh round of bull-run in the markets

The big three global rating agencies – Standard & Poor’s (S&P), Moody’s, and Fitch – together control a majority of the global ratings business, with the ratings provided by these agencies reflecting the fundamental strength of the issuer of the paper, be it corporates or the government. The sovereign credit ratings give investors insight into the level of risks associated while investing in a country, including political risks. These agencies evaluate the country’s economic and political environment, along with other macro factors, to determine a representative credit rating. The improvement in sovereign ratings suggests a corresponding improvement in these fundamental factors, which lowers the risks, while investing in the country. The higher sovereign ratings result in better lending terms, lower borrowing rates and higher foreign direct investments, as it reflects lower risk perception of the issuer country.

Recently, Moody’s had downgraded China’s credit rating from Aa3 to A1 – for the first time since 1989 – but has changed its outlook from negative to stable, as it sees higher risks from a slowing economy, higher stimulus-based growth leading to rise in economy-wide debt levels and weaker debt servicing capacity. China has been growing aggressively over the past few decades, investing heavily in infrastructure and adding fresh capacities through debt financing. China’s debt to GDP ratio has gone up from ~250 per cent of GDP in 2015 to ~280 per cent by end 2016, but economic growth has been falling from 10.6 per cent in 2010 to 6.7 per cent last year. Moody’s has also warned China of another downgrade, if the debt bubble is not fixed.

S&P had maintained China’s credit rating at AA- with negative outlook, citing increasing economic and financial risks that could lead to a possible downgrade for the country. Fitch had maintained China’s rating at A+ with stable outlook during its last review. The rating downgrade by Moody’s reflects the expectation that China’s financial strength will erode somewhat over the coming years. Economists are clueless about the extent of problems in the Chinese economy.

On the other hand, S&P has maintained India’s sovereign ratings at the lowest investment grade – BBB-minus, with a stable outlook – despite India’s improving fundamentals. The key reasons cited by S&P for not upgrading India’s sovereign rating is India’s lower per capita income and weak public finances. Over the past few years, India’s external position has improved significantly. Lower investment grade has led to higher cost of borrowings in global
markets due to investor risk perception.

India’s fundamentals have improved significantly since the Modi government came to power in May 2014. Inflation and the twin deficits are under control, resulting in lower interest rates. The government is determined to follow the fiscal consolidation roadmap in a disciplined manner. There is a decisive push in policy making, passing of key legislation, improving business climate, bringing reforms in the power sector, addressing issues in the banking sector, tackling subsidy issue heads-on, etc. The new indirect tax, GST, will simplify indirect taxation and add to GDP growth. The government’s push towards spending on large infrastructure projects and encouraging foreign companies to set up manufacturing facilities in India through the ‘Make in India’ programme will provide employment opportunities and result in increase in demand.

India is currently experiencing the most stable political climate in past many decades. The ruling BJP government at the Centre has a clear mandate till 2019 to push through reforms. Despite taking tough decisions, it has managed to win many state elections decisively. The ongoing trend points towards the possibility of another five-year term for BJP during the General Elections in 2019.

While S&P has refused to upgrade India’s credit rating even next year, there is a possibility that other rating agencies might soon upgrade India’s rating, resulting in a rise in foreign investments into the country. The possible downgrade of China by other rating agencies should also provide an opportunity for India.

There is a clear investment momentum seen among foreign investors towards India. Even without a rating upgrade, India has retained its top position in attracting Foreign Direct Investment (FDI) for the second consecutive year in 2016 ($62 billion) much ahead of China ($59 billion) and the US ($48 billion). This clearly shows that India continues to be the preferred choice for the foreign investors as a long-term investment destination. The sovereign rating upgrade for the country would act as an icing on the cake

This article was originally published in Business India Magazine.
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Disclaimer: The views expressed in this article are personal and the author is not responsible in any manner for the use which might be made of the above information. None of the contents make any recommendation to buy, sell or hold any security and should not be construed as offering investment advice.