Moody's affirms Baa3 rating for India; raises concerns over political challenges

However, the agency issued a cautionary note concerning potential political challenges and pointed to instances such as the ongoing unrest in Manipur as examples.

The state of Manipur in northeastern India has been grappling with an ongoing ethnic conflict for several months, resulting in reported incidents of violence.

"…the curtailment of civil society and political dissent, compounded by rising sectarian tensions, support a weaker assessment of political risk and the quality of institutions," Moody's said in a statement.

"Although elevated political polarisation is unlikely to lead to a material destabilisation of government, rising domestic political tensions suggest an ongoing risk of populist policies—including at the regional and local government levels—amid the prevalence of social risks such as poverty and income inequality, as well as inequitable access to education and basic services. Moreover, the periodic flaring of border tensions with neighbouring countries was an outlier among sovereigns assessed as having a lower overall susceptibility to political risk," it added.

On August 18, the situation escalated further with reports indicating that three individuals lost their lives in the latest outbreak of violence.

Regarding the economic aspect, Moody's still considers India to be one of the world's swiftly growing economies. However, the credit rating agency did highlight that the country's potential for growth has diminished over the past 7-10 years.

According to the ratings agency, India's potential growth has improved to 6-6.5 percent from sub-6 percent levels during the coronavirus pandemic. However, India's potential growth rate "remains lower than estimates in excess of 7 percent in the middle of the last decade," Moody's said.

It added that the government's focus on capital expenditure has resulted in "tangible improvements" in logistics performance and the quality of trade and transport-related infrastructure.

Other positives include the digital public infrastructure, formalisation of the economy, broadening of the tax base, and "fundamental improvement" in the banking system over the last three years.

"Despite some progress in developing the manufacturing sector in recent years, structural weaknesses including trade barriers and protectionist measures and low education and skills levels for a large part of the population," Moody's noted.

However, the economy's limited ability to significantly increase manufacturing output and improve job creation is seen as limiting potential growth.

Nevertheless, a significant rating vulnerability for India continues to be the government's fiscal condition.

Moody's asserts that unless there are substantial improvements in revenue, the government will face difficulties in attaining its fiscal deficit goal of 4.5 percent of GDP by the fiscal year 2025-26.

"Consequently, Moody's projects general government debt to stabilise at around 80 percent of GDP over the next two to three years, lower than the peak of almost 90 percent reached in 2020-21 but higher than many similarly-rated sovereigns," the agency said.

The government is targeting a reduction of its fiscal deficit to 5.9 percent of GDP in the fiscal year 2023-24. However, current data shows that the fiscal deficit for the first three months of the financial year has already reached 25 percent of the full-year target.

Although a strong nominal GDP growth is anticipated to support fiscal consolidation efforts, apprehensions persist regarding the proportion of India's interest payments in relation to its revenue, particularly when compared to countries with similar credit ratings.