A broad range of reforms, ranging from tax to fiscal, initiated by the Narendra Modi government, will be instrumental in improving the country's credit profile if implemented successfully, Moody's Investors Service said in a report.
The report expects muted near-term impact from the implementation of the Goods and Services Tax (GST), it sees structural issues plaguing public sector banks as a hindrance in resolving the NPA crisis.
The decision of the central government to withdraw higher denomination currency notes will improve financial inclusion efforts as well as enhance the country's tax base, the report said. Moody's also sees the Fiscal Responsibility and Budget Management (FRBM) framework as an opportunity to set a medium-term target for the country's debt burden.
Also Read: India Government Debt Remains `Significantly' High, Moody's Says
GST: A Medium-Term Play
The implementation of the Goods and Services Tax on July 1 will only have a muted impact on inflation and a ‘moderately disruptive' impact on Indian businesses as real effective tax rates are unlikely to rise higher, the report said.
The economy has already demonstrated its resilience to a temporary shock (demonetisation). The planned introduction of GST should be less disruptive.Moody's Investor Service Report
Although Moody's expects the transition to the GST Network to take up to six months, it does not see the reform having a significant impact on the country's growth.
GST will improve the ease of doing business while enhancing India's prospects as a foreign investment destination, Moody's added. The indirect tax reform is also expected to incentivise tax credits, make compliance easier through a common information technology infrastructure, thereby positively impacting the government's coffers.
Higher foreign investment, coupled with higher revenue for the government will improve India's credit profile which is constrained due to a low revenue base, the report said.
Also Read: There Are 160 Reasons India Won't Escape Sales Tax Chaos
NPA Crisis: Near-Term Structural Challenges
The government's decision to empower the Reserve Bank of India to resolve the bad loans situation can hasten the process but only if the government also address the problem of lack of capital state-owned banks at the same time, Moody's said.
As most of the large NPA accounts involve a consortium of banks and specific borrowers, the steps taken by the government will improve co-ordination among the lenders.
Moody's believes that continued stress within the infrastructure, power and steel sectors coupled with weak profitability of these companies dents their ability to service loans and deleverage balance sheets. As a result, banks will need to take large haircuts.
Public sector banks' weak capital levels limit their ability to take such write-downs. To do so, would require simultaneous capital injections from the government, which the government has indicated it is not prepared to do at this stage.Moody's Investor Services Report
The report expects public sector banks to use most of their profits over the next two years to increase their loan coverage, after which they can be in a position to clean up their balance sheet.
Note Ban To Help Strengthen Fiscal Framework
The government's decision to withdraw currency notes of high denomination on the night of November 8 has helped increase the penetration of the banking system in the country. This was evident from the rise in the number of accounts opened under the Pradhan Mantri Jan Dhan Yojana (PMJDY), said the report.
Over time, demonetisation will be instrumental in shaping India's fiscal and institutional framework by enabling a reduction in tax avoidance and corruption.
Increased integration of economic activity within the formal financial system will help strengthen the basis for both tax revenue generation and more efficient government expenditure.Moody's Investor Services Report
The number of duplicate and fake accounts has also been reduced by the government's effort to link welfare schemes through the National Payment Corporation of India directly into the citizen's bank account as well as through passage of the Aadhaar Law in March 2016, the report added.
FRBM Framework To Help Reduce Debt Burden
According to Moody's, India's debt burden is very high relative to its peer group. “Although the debt declined to 67.5 percent of the GDP in 2016 compared to 84.7 percent in 2003, it is still significantly higher,” the report said.
The efforts of the current government are 'supportive' of the country's credit profile, Moody's says. But the the reduction in the central government's deficit has been offset by a rise in state deficits, the ratings agency warned.
Successful implementation of the recommendations would help strengthen India's credit profile and provide a clear roadmap toward reducing the sovereign's high debt burden.Moody's Investor Services Report
Moody's considers the FRBM committee's fiscal deficit targets to be achievable. An improvement in revenue collection due to higher tax compliance and a positive medium-term impact from the GST will act as an impetus to achieve these targets.
Also Read: FRBM Committee Recommends Glide Path To Bring Fiscal Deficit Down To 2.5%
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