Moody’s Investors Service has upgraded India’s ceiling for foreign currency bonds and government's foreign currency issuer ratings to “Baa3” from “Ba1” due to a reduction in external vulnerability, rising foreign investment, and vibrant economic growth.

The outlook for both the ratings are stable, the global rating agency said in London. The agency also revised upward its outlook on the “Ba2” country ceiling for foreign currency bank deposits from negative to stable. The outlook on the government’s “Ba2” domestic currency rating remains negative, it said. Moody’s said the principal driver behind the rating changes is the reduction in external payments vulnerability. Forex reserves have also increased to over $100 billion.

In addition to the external liquidity situation, India’s more resilient economic performance, was seen during 2002’s drought-induced shock when gross domestic product growth stayed above 4 percent. Forecasts for the current year’s expansion have been adjusted upward to eight per cent.

Moody’s said the concrete progress on controlling India’s fiscal deficit across all levels is still desirable in order to stabilize the government’s domestic currency rating. Accordingly, the agency will watch for more ambitious implementation of public sector and labour market reforms following the upcoming national elections.

Fitch Ratings, another global rating agency, on Wednesday upgraded India’s long-term foreign currency rating to “BB+” from “BB.” Moody’s said the current account is likely to shift from a modest surplus position to small deficits in the next two years because of vigorous import demand, although capital account surpluses are expected to exceed any such shortfalls and further bolster reserves.

Given the scale of the foreign assets, the government’s payment capacity should be able to withstand any foreseeable shocks or capital outflows emanating from the otherwise worrisome fiscal situation. Moody’s also noted the recent moves toward a rapprochement between the Indian and Pakistani political leadership, although the peace process is at an early stage and depends uncomfortably upon the leaders’ continuance in office.

In the event that the negotiations can meaningfully reduce regional tensions, the potential exists for a reallocation of scarce resources from defence to social welfare programs. In most emerging market countries, Moody’s aligns the country ceiling on foreign currency bank deposits with the government's rating on its local currency debt. Historical experience shows payments problems for these two classes of debt to be closely connected.

In India’s case, this linkage has been marginally loosened for now, with a negative outlook on domestic currency debt and a stable outlook on the bank deposit ceiling. This distinction reflects the fact that banking system’s assets and official foreign reserves are substantial compared to non-resident deposits, even though a meaningful portion of these is likely to be withdrawn in the event of a domestic fiscal crisis.