Coalition crutches could cramp reform chase, say Moody’s, Fitch

With the BJP losing an outright majority in the Lok Sabha, global rating agencies on Wednesday said navigating far-reaching reforms may prove more difficult during a coalition-dependent third term likely for Prime Minister Narendra Modi.

Upsides to India’s growth prospects would be modest if reforms face hiccups, while structural weaknesses like youth unemployment and ebbing foreign investment flows pose a long-term risk, they said. While “broad policy continuity” is expected in areas such as the thrust on public capex to spur the economy and gradual fiscal consolidation, a BJP-led government that needs “to rely more heavily on its coalition partners” could find it tougher to push contentious reforms, particularly around land and labour, recently flagged as the party’s priorities, said Fitch Ratings director Jeremy Zook. “We expect India’s strong medium-term growth outlook to remain intact, underpinned by the government capex drive and improved corporate and bank balance sheets. But upsides to medium-term growth prospects are likely to be more modest if reforms prove more challenging to advance,” Mr. Zook, who is the firm’s primary sovereign analyst for India, added. In a comment on the Indian government’s sovereign rating, titled “Incumbent victory suggests policy continuity while fiscal metrics to remain weak”, Moody’s Ratings said the NDA’s “relatively slim margin of victory as well as the BJP’s loss of its outright majority in Parliament” may delay more far-reaching economic and fiscal reforms that could impede progress on fiscal consolidation. Noting India’s fiscal outcomes will remain weaker than its peers, the firm’s senior vice president Christian de Guzman said India is projected to grow faster than all other economies in the G20 through fiscal year 2025-26, but the near-term economic momentum masks structural weaknesses that pose risks to long-term potential growth. These weaknesses include “high levels of youth unemployment across sectors”, “weakness in productivity growth” in India’s large farm sector that still accounts for 40% of all employment, and the decline in inward foreign direct investment (FDI) flows in each of the past three years.

“The erosion in inward FDI is despite a favourable economic and geopolitical backdrop for India amid broader U.S.-China strategic tensions, suggesting continued constraints from the investment climate,” Mr. de Guzman pointed out.

While India may be able to meet its fiscal deficit target of 4.5% of GDP in 2025-26, its fiscal consolidation since the pandemic has not outperformed other Asia-Pacific emerging markets while its fiscal and debt metrics remain weaker than other peers, including Indonesia, Philippines and Thailand, Moody’s said. “In addition, India’s fiscal metrics, whether aggregated at a central government or general government level, would remain worse than before the pandemic, when India’s rating was higher at Baa2,” the rating firm commented. India is currently rated ‘Baa3 stable’ by Moody’s, the firm’s lowest investment grade rating.

“We project the general government debt to stabilise at above 80% of GDP over the next three years, as compared with 70.5% recorded in fiscal 2018-19; we also forecast general government interest payments to fall to around 24% of general government revenue over the next two years from over 28% in fiscal 2020-21, but will still be higher than the corresponding ratio of less than 23% in fiscal 2018-19,” it said.