‘BBB-’: A Fundamental Country Running on Debt

Credit rating agencies assess the creditworthiness of countries based on various factors, including economic indicators, fiscal policy, political stability, and debt levels. The credit rating assigned to a country helps lenders determine the risk associated with lending to that country and influences the interest rates they charge. Sovereign credit ratings seek to quantify issuers’ ability to meet debt obligations. These can facilitate countries' access to global capital markets and foreign investment when favourable. A higher credit rating indicates a lower perceived risk and, therefore, lower borrowing costs. On the other hand, a lower credit rating implies a higher risk profile, which leads to higher borrowing costs, which is the case for India.

As of January 2024, India held a rating of ‘BBB-’ (Fitch), Baa3 (Moody’s) and ‘BBB-’ (S&P). This positions our economy as a borderline investment grade with a stable outlook. The rating was neither upgraded nor degraded since its announcement in 2020 during the pandemic. High Debt/GDP ratio, high Deficits and Interest/Revenues ratio, lagging structural metrics and such metrics were highlighted for rating India as the lowest investment grade.

India: Running on Debt

The main metric highlighted in the rating was that is India heavily depended on debt which presents a fiscal challenge overpowering the robust growth of the country. Its Debt-to-GDP ratio standing at 84% posed a challenge to look at the economy with a positive outlook. Though, neither the metric nor the concern for potential default assumed by the agencies was wrong, it was necessary to take into account that credit ratings map the probability of default and therefore reflect the willingness and ability of borrowers to meet their obligations.

India’s willingness to pay is unquestionably demonstrated through its zero sovereign default history. India’s ability to pay can be gauged not only by the extremely low foreign currency-denominated debt of the sovereign but also by the comfortable size of its foreign exchange reserves that can pay for the short-term debt of the private sector as well as the entire stock of India's external debt including that of the private sector.

A low rating leading to a high interest rate pushes the country deeper into the Debt/GDP ratio requiring better fiscal management and lesser borrowing that might in turn hamper the infrastructural growth of the economy. Even with better fiscal management but poor growth, the chances of an upgrade would be slim.

Emerging Economy Unaccounted For

The concerns, metrics and qualitative measures used by credit rating agencies show a clear bias towards developed countries as they fail to account for the non-fiscal strategies of emerging economies. 

India became a clear outlier on several parameters, not just now but for the past two decades. It is the first country to get the lowest investment grade as the 5th largest economy. Not only does it affect the flow of Foreign Investments and India’s position in the global markets, but it also affects the rate at which India can borrow its funds as an emerging country. As stated, with an 84% Debt/GDP ratio the growth of the country is dependent on its fiscal power which is taken away when it's rated the lowest investment grade. This is not just the case with India but any emerging economy as these agencies become extremely conservative in their outlook towards them.

Through the years the rating for India has not improved much, it should be noted that the rating and macroeconomic indicators have had low or zero correlation. Even though the borrowing capacity of India remains stable or grows, the effect of a high-interest rate is not catastrophic as the fundamentals of the economy are not captured in ratings. India may be upgraded to a better that reflects its fundamental working better but even if not, it shows the path on which it still needs to improve to come at shoulder’s length with the developed countries.