India has potential; growth with lower debt, fiscal deficit key to ratings upgrade, says Atsi Sheth of Moody’s Ratings

Moody’s upgraded India’s FY27 growth to 7% from an earlier projection of 6%, betting big on the consumption and investment themes currently playing out in the economy. While Indian growth is intact and the agency is confident about the Indian economy, a ratings upgrade may still be distant. Atsi Sheth, Chief Credit Officer, Moody’s Ratings, said in an interview with Fortune India that the same growth with lower debt and fiscal deficit are crucial factors for a ratings upgrade.

Edited excerpts:

Kumar: The Indian economy has beaten the tariff, and West Asia crisis blues, and growth momentum sustains. Moody’s has revised India’s growth projections for FY27 to 7% from 6%. What is the basis of Moody’s confidence in India amid the crisis?

Sheth: When the Middle East conflict began, considering energy, El Niño, and global risk sentiment, we said there’s probably going to be a growth effect of this conflict. The channels would be the direct effect of oil and the indirect effect through inflation and the exchange rate.

As we monitored the data, we found a couple of things. One is something common beyond India. The energy shock hit the global economy when global oil reserves were actually quite good, and that has been a buffer. The big economies were well buffered.

The second thing is that the sentiment effect on markets and funding costs, which we monitor, was not as negative. Energy inflation certainly went up. What we observed, especially in the second quarter of the fiscal year, is that growth was quite broad-based.

We updated our forecast as consumption has not been affected to the extent that we thought it would, despite higher energy costs and some food inflation as well. Second, investment accelerated quite a bit compared to what we’ve seen even in the recent past, and that’s a big factor.

Third, from the output side, we’re seeing both manufacturing and services continue to grow. PMIs are above 50 in both cases. So, we think the momentum has been much more resilient than we’d anticipated. The data have not borne out our initial fears. So, we’ve upgraded, and we think that momentum will lead to overall growth of around 7%.

Q. You mentioned investments. While the government is driving public capital expenditure, private investment is a concern in the Indian economy. What broader themes are you witnessing in private investments in India?

A: You’re absolutely right that the infrastructure spending, the capex from the public sector, has certainly been a big driver. Theoretically, you’d expect the public sector to do that, and it should crowd in the private sector. We are seeing some of that effect on the private sector as well. It’s interesting.

Without speaking to a particular company, India remains a domestic consumption story, and that remains quite strong. But it’s not just consumption. Some of the heavier infrastructure and trade-related sectors as well that are seeing a push.

The consumption story of India, domestic demand, was never in doubt. The crowding in, whether all this capex from the government would give the private sector the comfort to invest themselves, seems to be playing out as well.

The third thing, which we’ll be watching more closely because the jury is still out, is that globally supply chains are being rejigged as a result of tariffs and geopolitics. What we are looking for is how India is being factored into these supply chain rejig stories.

Q: What are the factors behind this consumption story playing out in the Indian economy at a time when there is a crisis, energy prices and inflationary expectations are high, and the RBI has begun monetary tightening?

A: In India, we don’t have enough granular data by income levels to say whether the consumption story is truly broad-based or whether it’s one segment or the other. But from the general data that we observe, this is the classic income growth story.

India has not solved the jobs problem. The demographics are such that you still need job creation to accelerate to meet the aspirations of the people. But we have still seen income growth. Incomes may or may not be growing in line with inflation (above inflation or not), but overall income is growing, and that is giving purchasing power to people.

Q: The Indian economy is one of the fastest-growing global economies. It has beaten the odds successfully so far, on the back of several reforms and government initiatives. But still, from the ratings side, we remain constrained. Are rating agencies (and I mean Moody’s only) looking at the traditional levers or areas of the economy, or will you also consider the new initiatives being taken? Why is it that the same thing is not reflected on the rating side?

A: India’s growth story has always been a big positive in our rating analysis. Even when the story was in doubt, when growth was not at the level it is today, we didn’t downgrade. Our view is that India has the potential. We see the private sector and the public sector continuing along a path that will lead to at least some of this potential being realised. So, Moody’s has always said that India’s growth potential and its actual growth are a big source of credit support.

Now, we’re a rating agency. Our job is to assess the ability of an entity to repay its debt, and debt has to be a consideration in that. In India, despite the huge growth, the fiscal deficits and debt are not coming down. The same growth with lower debt and deficits would then mean a higher credit rating. As it stands, the growth is just enough to sustain this level of debt, because that level of debt is quite high.

The second thing I’d say is about the way India’s tax base works. Compared to advanced and other emerging markets, in India the largest share of tax revenue comes from corporate taxes rather than personal income taxes, because of the demographics. So, the revenue base is such that a good portion of revenues goes into paying interest. We say the growth is there, but it won’t necessarily translate into huge increases in government revenue or huge declines in government spending. When we see the growth translating into the government balance sheet metrics, that’s when I think we would look again. We’re always looking at it.

Q: What are the challenges that you see going forward? In the context of El Niño and rising interest rates, how do you see inflation and growth dynamics playing out?

A: It is our view that we have simply entered a new macro regime where uncertainty on the macro front, from geopolitics, from technology, from weather events, is just higher than it was a couple of decades ago.

Kumar: It’s the new normal…

Sheth: Yes, volatility is now the new normal. One thing that has supported the macro-outlook for India is risk mitigation - strategies to ensure availability of energy imports.

Every time people talk about El Niño, every time there’s an early monsoon warning, people say, “Risk, risk, risk”. Actually, very few ratings change because of El Niño, because it tends to be an amplifying factor if you’re already at risk. If you have risk mitigants and buffers, El Niño does not have that much of a credit effect.

In India’s case, food reserves are a risk mitigant at the current time, because we’ve entered this El Niño year and India has food reserves. That could be a positive. India is of course a food producer, and it tends to use export controls as a way to mitigate risk. So India has these levers to pull for El Niño.

Q: Coming back to your point on sovereign debt, it is a concern globally. What are the potential impacts?

A: First, an observation about global debt: the cost of global debt is rising in advanced economies this time, compared to emerging markets. If you look at where markets are pricing, the concern is advanced economy sovereign debt. Our own research has shown that for a select number of big economies, the cost of servicing this debt is actually going to add to your debt, because interest costs are rising so much when your debt levels are high. That’s a bit of a negative cycle.

The second concern around rising debt is that your shock-absorption capacity erodes. During the pandemic, you had the fiscal space; what about the next shock that happens? The third thing, especially in advanced economies, is that today’s sovereign bond yield is also the mortgage cost. That has a direct effect on the housing market, which has so many positive and negative implications. From our perspective, there’s a credit angle, a growth and financial angle, and a risk angle: your shock-absorption capacity is lower.