Reforms to aid growth; banking sector risks remain: Moody's

New Delhi: Moody's Investors Service on Monday said continued reforms to enhance business environment and moderate inflation will help India achieve robust growth but cautioned that rising contingent liability risks in the banking sector could affect its credit quality.

Evidence of success in policymakers' efforts to introduce growth-enhancing economic and institutional reforms would provide support for a rating upgrade, Moody's said in its Annual Credit Analysis as it forecast GDP growth at around 7.5 percent for next two years,

"Sustained fiscal consolidation, stable inflation at moderate levels and progress on reforms aimed at enhancing the business environment would contribute to sustained growth at robust levels. In turn, persistent income and profit growth would raise government revenues and contribute to improved fiscal metrics. However, we expect the benefits to be very gradual," Moody's said.

India's credit profile is supported by strong growth potential and high private savings rate, it said.

"Conversely, signs of slippage in progress towards those goals or indications of rising contingent liability risks related to the banking sector could weigh on India's credit quality," Moody's added.

India's strengths are balanced against a high government debt burden (67.4 percent of GDP in 2015), regulatory and infrastructure constraints on its competitiveness, slow pace of policy reform, and the contingent liability risk to the sovereign from public sector banks' high and rising non-performing loans.

"Looking ahead, evidence of success in policymakers' efforts to introduce growth-enhancing and growth-stabilising economic and institutional reforms would provide support for a rating upgrade," it said.

Moody's further said that institutional strength is apparent in robust democratic apparatus. Offsetting weaknesses include an uncertain regulatory environment, corruption, a slow-moving judicial system and, in general, inefficiencies in the delivery of government services, it added.

"At the current juncture, political fragmentation leads to slow and ad-hoc progress on reforms. Progress on land and labour reforms, when it has occurred has been limited and gradual," it said.

Moody's said the positive outlook on India's rating reflects our expectation that policies over the next 12 to 18 months will support sustained growth, accompanied by narrower fiscal deficits, low current account deficits, increased savings and investment, and inflation that is within the central bank's target.

Over the past year, it said external developments favourable to India such as lower global oil prices have combined with policy measures to move the economy towards a more stable macroeconomic development with smaller fiscal deficits, lower inflation and a narrower current account deficit.

Moody's analyses India's credit profile in terms of

economic, institutional and fiscal strength and susceptibility to event risk.

"We expect corporates' profitability to remain muted which will continue to dampen their ability and willingness to invest in the next few quarters. We forecast real GDP growth at around 7.5 per cent in the next two years," Moody's said.

Material improvements to India's public finances will likely be limited in the near term, and deficit reduction will come from either cyclical upswings or tactical fiscal management, rather than a broad-based fiscal consolidation strategy.

Moody's said India's susceptibility to event risk is driven by banking sector risk. As banks continue to recognise bad assets, non-performing loans will rise further, particularly for PSBs, albeit at a slower pace than at the end of 2015.

The agency estimates the capital needs of PSBs to be notably larger than the Rs 70,000 crore of equity over the next four years proposed by the government.

"The authorities' focus on bad asset recognition and provisioning in the banking system as well as the recent passage of a new bankruptcy bill would be credit positive from a sovereign perspective, if it led to improved bank capitalisation levels, renewed loan growth and robust risk processes," Moody's said.

The US-based agency said that reforms to improve the business environment will help to realise India's growth potential, but the benefits of these measures would be very gradual.

The 'Make in India' programme aims to increase the share of manufacturing to 25 percent in 2020 from the current 16 percent. This implies growth in manufacturing value added of 12-14 percent per year, compared with only 8.1 percent in FY2016, Moody's added.

"But inadequate infrastructure, limited flow of workers from the agriculture sector and, to some extent, only moderate levels of investment in innovation will hamper growth in the manufacturing sector and the economy as a whole. These factors are likely to prevent a sharp improvement in India's competitiveness," it said.