Moody's Upgrade Offers Political Victory For PM Modi Ahead of Key Elections

Moody's Investors Service raising India's sovereign rating for the first time in 14 years is not only a vote of confidence for India's longer-term financial health at a time when the government's economic policies are facing criticism and growth has slipped to levels last seen in 2014, it has also offered a political victory to Prime Minister Narendra Modi and his at-times-controversial reform agenda.

The praise for the new goods and services tax (GST) and efforts to reduce the size of the informal economy gives PM Modi's party, the BJP, a boost ahead of a crucial election in his home state of Gujarat next month and its re-election bid in 2019.

At the same time, the upgrade -- to Moody's second-lowest investment grade rating from its lowest -- contrasts starkly with brewing problems on the domestic front. Dented by PM Modi's cash ban last year, growth dropped to 5.7 percent in the April-June quarter from 7.9 percent a year ago. The rollout of GST, called chaotic by critics, has further dampened sentiment, prompting the government to tweak tax rates several times amid growing criticism about the lack of employment creation and fears that India may miss its fiscal deficit target.

"In the short-run, difficulties in adjusting to the new GST and the expanded digital economy have led to some downturn in economic activity, but the prospects for the next couple of years leading up to the 2019 general elections definitely look optimistic," said Raghbendra Jha, Rajiv Gandhi professor of economics at Australian National University (ANU).

Reform Praise

Moody's praised PM Modi's efforts to broaden the tax base and tackle non-performing loans in India's $2.3 trillion economy, Asia's third-largest. Moody's said these reforms provide stability and "enhance India's high growth potential."

The agency also praised PM Modi's demonetisation policy, which sucked 86 percent of India's currency out of circulation last November for helping reduce corruption, increase the size of the formal economy and improve tax collection. The upgrade's timing is "opportune," and corrects "undue bearish sentiment over the last few months," according to Abhishek Gupta, a Mumbai-based analyst with Bloomberg Economics.

ANU's Jha said the upgrade could provide political stability, lead to more foreign direct investment inflows and boost jobs as the ruling BJP faces crucial elections. "This will increase jobs and have positive spin off effects on (PM) Modi's political prospects," he said.

Domestic Situation

Still, the vast challenges meant the upgrade was greeted with skepticism.

Some reforms praised by Moody's "are of questionable value both in the near-and medium-term," said Prasanna Ananthasubramanian, chief economist at ICICI Securities Primary Dealership, adding that the "loss of growth momentum in the last 12 months" outweighs benefits from additional savings.

The Moody's upgrade also comes amid expectations of fiscal slippage because of falling revenue collections, higher oil prices and government expenditures as it tries up to make up for weak private investment.

"We believe the central government will likely breach the FY18 fiscal deficit target of 3.2 percent of GDP by about 0.5 percent of GDP on lower revenues collections," said Tanvee Gupta Jain, economist at UBS Group AG. That's because of excise duty cuts on gasoline and diesel, lower telecom collections, a drop in the central bank dividend and higher government expenditures.

State governments are also under pressure to fund additional spending to pay for crores of rupees in waived farmer loans and higher salaries for government employees.

The upgrade might be a "reflection of the improvements" in India, said Hugh Young, head of Asia for Standard Life Aberdeen Plc. "I don't think in itself it will change much," Young said. "India needs to keep on making business life easier and more transparent and the money will flow."