Ratings upgrade some time away; to watch deficit: Moody's

She believes measures such as Jan-Dhan Yojana and Make In India will enhance sovereign profile.

Below is the verbatim transcript of Atsi Sheth's interview to CNBC-TV18’s Latha Venkatesh and Sonia Shenoy

Latha: Is the situation setting up for a rating upgrade for India at all?

A: Our outlook on India’s Baa3 rating is still stable. The report that you referred to that we did publish last week is talking about the growth conditions which we think are crystallising towards acceleration and that is certainly true. But as we say in the note it is not growth alone that will determine an upgrade but really how institutional matrix improves, how fiscal matrix improve, how the infrastructure environment improves as well.

Latha: Should we assume that as of March 1 if the fiscal deficit number has been bettered than what was budgeted last Budget, if the target for the next Budget is impressive at least lower than the 4.1 would that be enough reason, what else would you watch out for?

A: It is not a point in time estimate of any of these metrics, be it fiscal or inflation but a longer term outlook on where these metrics are said to go; that is what determines the rating and outlook. So, you talked about the Budget number in March and certainly we expect the government to come fairly close to meeting its central government deficit of 4.1 percent.

However, what we are looking at is the consolidated general government number which is still around 7 percent. So, if you add the central government plus the state government deficit that is at around 7 percent currently. What we are looking for is there visibility that will take that 7 percent number closer to the 3-4 percent that we see in other countries greater than BAA level. So, that is something that we would be looking at not just the last year’s or this year’s Budget deficit number. Similarly, for any of the other metrics that you could point to like inflation and growth.

Sonia: So what are the government measures if implemented that could enhance the sovereign profile of India?

A: Some of these have already been announced at least and we see them being implemented. There are two aspects to this, there are some measures that have been announced by the RBI and will be implemented by it. And there are some measures announced by the central government. There is also a third set of measures that could be announced by the state governments and implemented there.

We think each of these measures will be incremental for instance there is the Jan-Dhan Yojana that is announced by the Central Government, that will help the savings profile of India. There is the Make in India which is a term to describe numerous policies - be it related to infrastructure, be it related to labour reforms etc. We think all of these together although they are incremental will somehow lead to a crystallisation of growth that is sustainable over the long-term.

On the RBI side there is banking sector reforms which we think are very important. As we have talked about it before the banking system both asset quality and the capitalisation levels are constraints on the sovereign rating because they really point to a sustainability of the financial sector particularly its role in supporting growth in the future. So those areas of reform are also important. So that is a very broad range of measures but we think all of them will add up to supporting the sovereign profile. However, it will take time before these measures are actually implemented and then reflected in the matrix that we are looking at.

Latha: What kind of a time period are you looking at, just a Budget announcement on February 28 is not going to suffice, are we looking at a potential rating upgrade if the metrics fall in place six months ahead, one year ahead?

A: Our rating outlook is an organic thing; it is dynamic so we look at how things are evolving all the time. Here are the three things that we would be looking at. You talked about the Budget, so what we would be looking at is are measures in place today and they are not as of now but are there expenditures measures in place that could take the general government deficit from the 7 percent level lower down to the 5-6 percent and then towards a 4 percent level over the next three or four years; that is one.

Second, are conditions in place for inflation which the last numbers show 6.5 percent for consumer price index (CPI) 2.5 percent for wholesale price index (WPI) but are the pressures or the constraints on inflation that have led to recurrent pressures from time to time and inflation goes down and then it goes up again in India, so what sort of framework is in place both on the monetary side but also on the supply side that could keep inflationary pressures from recurring over the next three to four years.

Then the third aspect is how strong is the banking system, will it be playing a supportive role as growth accelerates as we expect it to or will it be a constraint on growth either because of inadequate capitalisation or continued asset quality problems. Those are the three broad things we would be looking at.

Latha: It is widely expected that inflation is going to be may be sub 5 percent in November, certainly sub 6 percent perhaps even in December. Will that suffice?

A: I would say no and here's why. In India given the demographics of the country and given the food supply demand issues, it is not just current inflation but what happens when you have a drought which happens from time to time or any weather-related changes in India, what happens is that inflation spikes quite dramatically at that time. There need to be measures in place to address this vulnerability to drought from time-to-time be it better irrigation, be it better management of stocks and that is what we would be looking at on the supply side with regard to food inflation which is a big driver of inflation.

One of the aspects of the inflation subsiding in recent months at least is commodity prices and that of course is linked to the global growth outlook. So we recognise that while inflation is coming down, some of the factors that lead to it coming down may be temporary. So it would depend on our view on commodity prices in the future. There is a third element that drives inflation up particularly if growth accelerates. Whether infrastructure and regulation keeps pace and allows investment to expand such that you don’t have inflationary pressures building up where demand builds up but supply is not keeping pace with that demand. So it is not just that whether it is 5 percent for a couple of months, or whether it will stay 5 percent four-five months, or whether the factors that lead to higher inflation at different points in time for different reasons, those factors are addressed or not.

Sonia: How much does the recent fall in crude bring the fiscal deficit target within reach and how much of a positive factor would that be?

A: The fall in crude is really very supportive for India in a couple of ways. One as you said the fiscal deficit target. Of course now it is better within reach than it was if this hadn’t been the case.

The second is in terms of policy the deregulation of diesel which we said it was credit positive for the sovereign, the fall in crude allowed this deregulation to happen without an inflationary impact. So it allowed a politically difficult policy measure to be taken and that is positive as well. And then of course the input prices for manufacturing and infrastructure coming off because of lower commodity prices set the stage for higher growth in India. That higher growth will eventually lead to higher revenues but not seeing that as the latest budget number show. We are not seeing those higher revenues yet but we think that will also help the budget over the medium term. So in three ways that is supportive.

Latha: What is Moody’s view on crude in 2015?

A: We think at current levels there is not a chance of spike for sure. How further down it goes will depend on the growth outlook. By now prices have really discounted the fact that growth is likely to be subdued in 2015. There is also demand and supply factors playing up here as well with the supply coming on stream. So we think that current levels will probably sustain.

Sonia: So you are saying that there won’t be any ratings upgrade, you will wait for the budget and then you will take a call?

A: We will wait for the budget and how the measures that have been recently announced how they are implemented to revisit our view on institutional strength and the constraints on India’s fiscal profile.