It's hard to please everyone. Prime Minister Narendra Modi has lured foreign bond investors to the world's fastest-growing major economy by getting tough on inflation and passing tax reforms. That's not enough for Moody's Investors Service to upgrade India's rating.
The highest debt-to-gross domestic product ratio among countries rated Baa3 by Moody's and a banking system saddled with bad assets are preventing the company from lifting its lowest-investment grade on Asia's third-largest economy, according to Marie Diron, senior vice president and sovereign analyst, who met Indian officials last week.
"India's debt burden is one of the factors constraining a higher rating," Diron said in an interview in Mumbai on Thursday. "Another factor is the banking sector -- the extent to which banks, in particular public-sector banks, pose a risk to the financial situation."
Moody's assessment comes as global funds are putting the most money into local bonds and stocks since March 2015 and the rupee is set to snap a five-quarter losing streak. While Moody's raised the nation's outlook to 'positive' from 'stable' last year, it is looking for evidence policy makers can sustain economic growth without worsening public finances.
At 67.4 percent in 2015, India's debt-to-GDP ratio was the highest among the similarly-rated nations, Moody's estimates. Modi's government has pledged to narrow its fiscal deficit to a nine-year low of 3.5 percent in the year ending March. S&P Global Ratings and Fitch Ratings rate India at BBB-, the lowest investment grade. Moody's on Friday cut Turkey's sovereign credit rating to junk from Baa3, citing rising risks related to external financing needs and a weakening in its credit fundamentals as economic growth slows.
A Bloomberg gauge of Indian sovereign debt has returned 5.5 percent since June 30, the most since the quarter ended Dec. 31, 2014. In the last three months, Modi has pushed through a goods and services tax, set up a monetary policy panel to decide interest rates and backed continuity by choosing former deputy governor Urjit Patel to head the central bank.
"There is a move toward a combination of economic, fiscal and monetary policy that would be conducive to stable growth, stable inflation and moderate current account and fiscal deficits," said Diron. "There is some progress in some areas of policy reforms. At the same time, there are areas where there has been less progress, such as the land and labor reforms. These changes are more challenging politically.''
Policy makers have also struggled to contain asset-quality problems at state-run lenders, weighing on credit growth. The government in February estimated the banking industry's stressed assets at around $120 billion.
"Compared to other sovereigns at similar levels, Indian banks are financially weaker," Diron said. "And for us, the extent to which it matters is that because of this financial weakness, in case there is a negative shock, support would likely come from the government."
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"What would lead us to potentially upgrade the rating would be a likely combination of factors," she said. "It can be faster progress in policy implementation toward that stable macroeconomic environment that then we would conclude would be positive for the fiscal metrics. Or it could be faster resolution of the bad assets problem in the banking sector.''
With imports meeting about three quarters of its oil requirements, India has been among the biggest beneficiaries of the plunge in crude prices in the last two years. Local markets have been buoyed by the global hunt for yield. Foreign investors poured 115 billion rupees ($1.7 billion) into government and corporate notes this quarter, while adding $3.9 billion in stocks.
The yield on India's 10-year bonds has fallen 66 basis points since the end of June and was down two basis points at 6.79 percent in Mumbai on Monday. While on course for its lowest close since June 2009, the yield is still the highest among major Asian markets after Indonesia. The rupee fell 0.1 percent to 66.7275 per dollar, paring its advance this quarter to 1.2 percent.
"India is by far the most attractive destination for foreign investors in all asset classes," said Krishna Memani, New York-based chief investment officer at Oppenheimer Funds Inc., which oversees $223 billion. "However, if there is any slippage on the monetary policy front or if political stability comes into question whereby the risk of falling back towards the policy chaos of the previous regimes increases, the bloom can come off the rose rather quickly."