Moody’s upgraded India’s sovereign debt rating from Baa2 to Baa3, the first upgrade in more than a decade. But what does this rating mean for its bond market now and for the future? Let’s discuss the factors that led to the rating change in the first place and its long term impact on Indian economy as a whole.
The Impact of Moody’s Rating on India’s Bond Market
The increase of India’s rating caused the ten year bond yield to open at just below seven percent the day after the rating increase. This was an increase of 12 basis points. By the end of the first business day, the ten year bond yield was 7.05%. Banks and corporations were the biggest buyers of these bonds, though there were other institutional and private investors. The yield increase and subsequent rush to buy the bonds ended the bear run in the Indian bond market.
The Impact of Moody’s Rating on India’s Economy in General
Baa3 is the lowest investment grade rating Moody’s has. India was upgraded to Baa2 based on expectations of improved growth. However, the rating change isn’t expected to increase foreign institutional investment. Many of those institutions are investing in factories and businesses to profit from domestic trade and exports to the broader Asian market.
The Moody’s rating increase was not totally unexpected. Yield on Indian bonds had risen nearly 10% since June 2017, while the credit default swap ratio had shifted by September 2017 to suggest investors’ expectations for India were improving. These signals are studied as a matter of course in an online master finance program.
What Led to the Rating Change in the First Place
India’s demonetization was by all accounts – barring tax collectors’ dreams – a disaster. People literally died because banks wouldn’t take their large notes as payment for fear they couldn’t exchange them before the deadline. India’s economy suffered a several point drop in its gross domestic product because the demonetization paralyzed the large cash day labor market while many businesses closed. This is why the Indian economy grew at only 5.7% in the quarter that ended in June 2017, the slowest pace in 3 years.
This issue will soon be studied in online master of science in finance programs as an example of what not to do when trying to purge a nation of counterfeit bills and bring the unbanked into the system. Bond prices could still be adversely impacted if there is a shortfall in GST tax collections, a rise in oil prices, or any issues with the PSU recapitalization plan announced at the end of October. Conversely, if recapitalization works, those entities will receive new cash to revitalize their businesses and improve cash flow while investors receive a new source of revenue.
India’s rating upgrade will have massive implications on its bond market. The yield of Indian bonds has increased, but this may be temporary if the economic policy changes fail to yield their expected results, if tax collections from GST reform are too low or the proposed recapitalization of state owned entities floods the market and brings down yields again.