Moody's Investors Service says that the structure of India's government debt -- which is largely owed domestically, in rupees, at relatively low real interest rates and at long tenors -- has mitigated the credit challenges stemming from India's high fiscal deficits and large government debt burden during a period of slower growth, currency volatility, and rising interest rates.
Moody's highlights that the government's debt financing profile benefited from an increase in India's domestic savings during previous years of high GDP growth, as well as from capital controls and bank liquidity requirements which channel a portion of private savings into government debt.
Over the last decade, the domestic financial system absorbed longer term government debt at relatively low real interest rates.
"Interest rates paid on Indian government debt have been significantly lower than India's GDP growth rate, and this interest-growth differential has led lowered the government debt/GDP and government interest payments/government revenue ratio over the last decade, despite wide fiscal deficits," says Atsi Sheth, a Moody' Vice President and Senior Credit Officer.
In the last three years, as interest rates have increased and growth has slowed, India's interest-growth differential has narrowed, yet it remains more favorable than in many similarly rated countries, and is a factor underpinning government debt sustainability.
"As macro-economic imbalances have heightened in the last few years, the currency, maturity and interest rate structure of government debt has supported India's sovereign credit profile and Baa3 rating," adds Sheth.
For instance, although government bond yields have risen significantly in the last year, the overall effective interest rate paid by the government has remained relatively stable, since a major portion of government debt was contracted at long maturities and fixed interest rates.
In addition, foreign currency debt and debt owed to non-residents is a relatively small portion of Indian government debt. Therefore, currency volatility and global risk aversion has a more limited impact on Indian government debt service costs than in countries where reliance on external debt is higher.
However, Moody's says that if current lower growth and high inflation persist over the medium term, the domestic financial system's capacity to absorb government debt could fall quite considerably. This could change the structure of government debt, raise debt financing costs and weaken government debt ratios. Such a development is not Moody's base case forecast at this time, but a risk that the agency is monitoring.