Moody’s Investors Service on Tuesday changed its outlook on India’s sovereign ratings to stable from negative. However, it retained the ratings, both on foreign and domestic currencies, at the lowest investment grade. Experts said this would have a beneficial impact on debt allocations by foreign portfolio investors (FPIs) to Indian papers.

“The decision to change the outlook to stable reflects Moody’s view that the downside risks from negative feedback between the real economy and financial system are receding,” said the ratings agency.

Now, Moody’s and Standard & Poor’s have a stable outlook on their ratings on India, while Fitch still has a negative outlook. All three rating agencies have given India the lowest investment grade.

Chief Economic Advisor Krishnamurthy Subramanian told Business Standard that there was ample scope for further re-calibration in Moody’s assessments with several reforms implemented in the financial sector and the prospects for the sector looking better. “It (Moody’s action) is a positive development that incorporates our consistent assessment about the strong fundamentals of the Indian economy,” he said.

The development came close on the heels of finance ministry officials pitching for a ratings upgrade during a meeting with Moody’s on September 30. The agency has now partly accepted the request.

Moody’s had said in the meeting that while India’s fiscal or financial strength, including its debt profile, had materially decreased, it had become less susceptible to event risks.

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William Foster, vice president – Sovereign Risk Group of Moody’s, told a TV channel that the outlook was changed to indicate that the economic recovery was getting entrenched. “There are still challenges from the fiscal deficit and debt burden, but the big risk from the financial sector has stabilised,” he said.

In June last year, Moody’s had downgraded India’s sovereign rating by a notch to the lowest investment grade and kept the outlook at negative. Foster said the negative outlook reflected lots of uncertainty that were there due to coronavirus and lockdowns.

On Tuesday, Moody’s said that with higher capital cushions and greater liquidity, banks and non-bank financial institutions posed much lesser risk to the sovereign than the agency had previously anticipated.

While risks stemming from a high debt burden and weak debt affordability remain, Moody’s expects that the economic environment will allow for a gradual reduction of the general government fiscal deficit over the next few years, preventing further deterioration of the sovereign credit profile.

Ranen Banerjee, leader of economic advisory services at PwC India, said the Moody’s move should lead to a higher allocation of debt by FPIs to bonds in India. So far as the equity market is concerned, FPIs do not look at ratings. However, it would assure FPIs that foreign exchange risks would subside now and this will have some effect on their allocations to equities in India, he said.

In Moody’s lexicon, India has Baa3 ratings. It said retaining the ratings balances India’s key credit strengths, which include a large and diversified economy with high growth potential, a relatively strong external position, and a stable domestic financing base for government debt, against its principal credit challenges, including low per capita incomes, high general government debt, low debt affordability and more limited government effectiveness.

India’s long-term local-currency (LC) bond ceiling remains unchanged at A2 and its long-term foreign-currency (FC) bond ceiling remains unchanged at A3.

The four-notch gap between the LC ceiling and issuer rating reflects limited political event risk that would significantly disrupt the economy and modest external imbalances, balanced by a large government footprint in the economy and limited predictability and reliability of government policies.

The one-notch gap between the LC and FC ceiling reflects limited external indebtedness and that, despite a history of several forms of capital controls, a debt moratorium remains unlikely.

The rating agency said it could upgrade the ratings if India’s economic growth potential increased materially beyond its expectations, supported by effective implementation of government economic and financial sector reforms that resulted in a significant and sustained pickup in private sector investment.

It could downgrade the rating to junk if there are weaker economic conditions than currently expected that point to lower growth over the medium term and resurgence of financial sector risks.

Think tank ICRIER said since ratings are lagged rather than leading indicators of economic performance, there is a need for the authorities to be prepared to deal with the onslaught of external headwinds blowing our way, rising commodity prices, fragility of global supply chains, tapering of hyper accommodative monetary policy stance in advanced economies and the global contagion of the Evergrande debacle to name a few.