Context: After nearly 36 years without an A-grade sovereign rating, India received a major upgrade from the Japan Credit Rating Agency (JCR) on September 2, raising its long-term sovereign rating from BBB+ to A-. The upgrade reflects confidence in India’s growth prospects, macroeconomic stability and structural reforms, while potentially improving access to capital.
India’s Journey from ‘A’ Grade to ‘Junk’ and Back
- India last held an A-grade sovereign rating in January 1988, when Moody’s assigned it A2.
- Rapid growth financed through borrowing during the 1980s weakened fiscal stability; by FY 1989-90, the Central government’s fiscal deficit had reached 9.1% of GDP, while the current account deficit stood at 3.1% of GDP.
- Political instability, including three Prime Ministers within three years, delayed reforms and weakened prospects for fiscal consolidation.
- The First Gulf War and rising oil prices further aggravated India’s external vulnerabilities and contributed to the Balance of Payments (BoP) crisis.
- By October 1990, India had been downgraded to Baa1, and by mid-1991, foreign-exchange reserves covered barely a few weeks of imports, leading to a further downgrade into non-investment grade.
- Despite substantial progress under successive governments after 1991, India remained below the A-grade for 36 years.
What are Sovereign Credit Ratings?
- Sovereign credit ratings are independent assessments of a country’s ability and willingness to meet its debt obligations, expressed through letter grades ranging from AAA to junk status.
- Ratings of BB+ and below are generally classified as non-investment grade or junk.
- A sovereign rating essentially indicates the probability of default perceived by the rating agency.
- Major agencies include S&P Global, Moody’s, Fitch, Japan Credit Rating Agency (JCR), Rating and Investment Information (R&I) of Japan, and Morningstar DBRS.
Parameters Used for Sovereign Ratings
Rating agencies generally assess:
- Institutional strength and governance, including policy credibility.
- Economic structure and growth prospects.
- External accounts and foreign-exchange reserve adequacy.
- Fiscal position, government debt trajectory and revenue capacity to service debt.
- Monetary-policy flexibility and broader macroeconomic stability.
- However, the methodology involves significant qualitative judgement, making the process relatively opaque and leading to concerns about differences in treatment between advanced economies and the Global South.
Why Sovereign Ratings Matter
- Sovereign ratings influence the decisions of international investors, financial institutions and corporate boards.
- Under Basel III, sovereign ratings remain embedded in banks’ capital requirements.
- An upgrade can potentially reduce the risk weight assigned to government debt, lowering the amount of capital banks need to hold against such assets.
- Lower risk weights can increase demand for sovereign bonds and potentially result in cheaper borrowing and funding costs.
- A downgrade can have the opposite effect by increasing perceived risk and funding costs.
- Therefore, even though ratings are not perfect measures of economic health, they can materially influence capital flows and investment decisions.
Why Did JCR Upgrade India?
The Japan Credit Rating Agency (JCR) cited several factors supporting its upgrade:
- India’s high growth rate of around 7%, supported by robust private consumption and public investment.
- The economy’s resilience despite tariff-related frictions, geopolitical tensions in West Asia and elevated oil prices.
- Continued macroeconomic and political stability and structural reforms.
- Stronger banking-sector health, with the gross non-performing loan (NPL) ratio declining to 1.8%.
- The Insolvency and Bankruptcy Code (IBC) and government capital injections have contributed to strengthening the banking sector.
- Personal income-tax cuts and reductions in Goods and Services Tax (GST) rates have also supported consumption and economic activity.
Recent Growth Performance
- The upgrade came shortly after India's first-quarter estimates for FY 2026-27.
- India recorded:
- Real GDP growth: 7.8%
- Nominal GDP growth: 10.3%
- Real GVA growth: 8.2%
- Gross Fixed Capital Formation (GFCF) growth: 11.9%
- These indicators point towards strong economic activity supported by both consumption and investment.
GDP Revision: Why the High Growth Numbers are Credible
- Critics questioned whether India's revised GDP estimates were designed to artificially increase the reported growth rate.
- However, GDP series are periodically revised globally as economic structures change and more detailed data become available.
- India has revised its GDP base series several times, including in 1948-49, 1960-61, 1970-71, 1980-81, 1993-94, 1999-2000, 2004-05, 2011-12 and 2022-23.
- The latest revision also addresses concerns highlighted in earlier International Monetary Fund (IMF) assessments regarding the outdated base year and excessive reliance on wholesale rather than producer prices.
- The new methodology introduces an Output Producer Price Index, adopts double deflation across sectors, including manufacturing, and aligns more closely with the System of National Accounts (SNA 2008).
- The Ministry of Statistics and Programme Implementation (MoSPI) has clarified that the revision was not intended to artificially raise the current year's growth rate.
- The improved implicit deflator incorporates more than 300 individual price deflators, providing greater granularity.
What is Double Deflation?
- Double deflation separately deflates the value of output and intermediate consumption using appropriate price indices to obtain more accurate estimates of real value added.
- It can improve the measurement of real economic activity, particularly in sectors where input and output prices behave differently.
Why the ‘A-’ Upgrade is Significant
External Validation
- The JCR decision was an unsolicited upgrade, meaning it was an independent assessment rather than a rating negotiated with the Indian government.
- It therefore represents an external vote of confidence in India's economic fundamentals.
Institutional Strength
- The upgrade recognises the importance of institutions created through Centre-State cooperation, with the GST Council being a major example.
- The GST Council represents a form of pooled fiscal sovereignty, bringing the Union and States together in indirect-tax decision-making.
Investment Implications
- An improved sovereign rating can reduce the risk premium associated with India in corporate and investor decision-making.
- This could support Foreign Direct Investment (FDI) and broader inward capital flows.
- The upgrade may also create a “nudge effect” on other rating agencies, as agencies are generally reluctant to remain conspicuous outliers.
Scope for Further Rating Upgrades
- Despite the JCR upgrade, other major agencies continue to rate India below the A-grade:
- S&P Global: BBB
- Moody’s: Baa3
- Fitch: BBB-
- JCR’s upgrade could increase pressure on these agencies to reassess India’s rating if economic fundamentals continue to improve.
- A broader convergence towards A-grade ratings would further strengthen India's international credit profile.
Structural Reforms Behind India’s Resilience
- The significance of the upgrade lies not merely in India's current growth rate but in the structural nature of improvements in the economy.
- Reforms such as the GST, Insolvency and Bankruptcy Code and banking-sector recapitalisation have strengthened institutional and financial foundations.
- Improving bank asset quality, stronger investment and resilient domestic consumption have increased India's ability to withstand external shocks.
- The upgrade came despite trade tensions, geopolitical instability in West Asia and high oil prices, indicating greater perceived resilience of the Indian economy.
Broader Significance for India
- India currently combines strong growth, inflation within the targeted band, improving banking-sector health and continued capital inflows.
- The return to an A-grade after 36 years represents more than a numerical improvement in creditworthiness; it signals greater international confidence in India's long-term growth trajectory and institutional capacity.
- The experience also highlights the importance of sustained fiscal prudence, structural reforms, macroeconomic stability and institutional credibility in maintaining sovereign creditworthiness.
- The broader lesson is that India's credibility should ultimately rest on sustained economic performance and institutional resilience, rather than on any single rating or isolated successful indicator.
Prelims Question
Q1. With reference to sovereign credit ratings, consider the following statements:
- A sovereign credit rating primarily reflects an assessment of a country's ability and willingness to service its debt obligations.
- An improvement in sovereign credit rating can potentially reduce the risk premium demanded by investors and lower the government's borrowing costs.
- Under Basel III, sovereign ratings can influence the risk weights assigned to sovereign exposures of banks.
- A sovereign rating upgrade necessarily implies that the country's public debt-to-GDP ratio has declined.
Which of the statements given above are correct?
(a) 1 and 2 only
(b) 1, 2 and 3 only
(c) 2, 3 and 4 only
(d) 1, 2, 3 and 4
Answer: (b) 1, 2 and 3 only
Explanation:
- Statement 1 — Correct: Sovereign ratings assess perceived creditworthiness, including the ability and willingness to meet debt obligations.
- Statement 2 — Correct: Better perceived creditworthiness can reduce the risk premium and potentially lower funding costs.
- Statement 3 — Correct: Sovereign ratings remain relevant under Basel III in determining risk weights and hence banks' capital requirements.
- Statement 4 — Incorrect: Debt dynamics are one among several factors considered by rating agencies. An upgrade does not necessarily require a decline in the debt-to-GDP ratio; growth prospects, external resilience, institutions, banking-sector health and policy credibility can also matter.
