S&P rating upgrade: how India earned it and what lies ahead

The Indian government has over the last several years aggressively pursued the three global agencies — S&P, Moody’s Ratings, and Fitch Ratings — for higher ratings that, in its opinion, better reflect the economy’s fundamentals. In fact, New Delhi has repeatedly expressed its displeasure over the agencies’ methodologies, saying they were biased against emerging economies. The Economic Survey for 2020-21 even had a chapter titled ‘Does India’s Sovereign Credit Rating reflect its fundamentals No!’.

“The rating of India did not capture India’s fundamentals for almost a decade,” Soumya Kanti Ghosh, State Bank of India’s Group Chief Economic Adviser, said in a note on August 14.

So, what has convinced S&P that now is a good time for India to be given an upgrade?

Steady economic improvement

The primary reason is clarity on the government’s finances. While the Centre has had a law called the Fiscal Responsibility and Budget Management Act since 2003 — it demands reducing the annual fiscal deficit to 3 per cent of GDP — it has rarely been met. In fact, only once since the Act’s enactment has the Centre’s fiscal deficit fallen below 3 per cent, in 2007-08, and that was primarily due to some financial jugglery. It was in January 2007 that S&P had last upgraded its rating on India.

However, post the Covid-19 pandemic, the fiscal deficit has been reduced aggressively from 9.2 per cent in 2020-21 to the current fiscal’s target of 4.4 per cent. Going forward, the Centre will start targeting a reduction in its debt-to-GDP ratio from 57.1 per cent in 2024-25 to 49-51 per cent by 2030-31.

Then there is growth. Despite GDP growth falling to a four-year low of 6.5 per cent in 2024-25, India remains one of the fastest growing large economies in the world — or in S&P’s words, “among the best performing economies in the world”. And this is real, or inflation-adjusted, growth; nominal growth — which is the actual increase in the GDP in today’s prices — is even higher. When it comes to calculating the debt-to-GDP ratio, it is the nominal GDP that matters. As such, as long as nominal GDP growth is higher than the pace with which the debt is increasing, the debt-to-GDP ratio will keep falling.

Another key factor has been the fairly low and stable domestic inflation, with S&P praising the Reserve Bank of India’s inflation management record. As per latest data, India’s headline inflation rate had fallen to 1.55 per cent in July — the lowest since mid-2017. Low and stable inflation is crucial to foreign investors as sharp increases in prices can erode their investments, weaken growth and the domestic currency, and create social unrest — all factors that can lead to a rating downgrade.

Why credit ratings matter

A credit rating is nothing more than a measure of an entity’s creditworthiness, or how likely it is that they may pay back borrowed money. If you repay loans and credit card bills on time and in full, your credit score improves. It is the same for countries.

Most countries need to borrow money every year to fund some of their expenditures. The difference between the total income and the expenditure for a year is the fiscal deficit; the Indian government’s is Rs 15.69 lakh crore for 2025-26. This has to be met by borrowing money from the markets, with the government paying interest on it. Now, if the government is seen as being more likely to repay the loan — which is what a higher credit rating indicates — the rate of interest is lower.

According to Madhavi Arora, Chief Economist at Emkay Global Financial Services, the rating upgrade “can open the door for new pools of global funds’ capital”, resulting in “lower cost of funding across macro agents’ curves, including corporates — especially those borrowing abroad”.

The rating scale

To be sure, India’s rating category with S&P has itself not changed — the country remains in the BBB zone. It’s just that it has gone from the lowest edge of it, or BBB-, to a more secure position. The next step would be BBB+.

Ratings are divided into two rough classes: investment and speculative grades. Entities, including countries, in the former class are worth investing in, while repayment of loans taken by those in the latter is more difficult to predict. But even within the investment grade, there are levels, and BBB is the lowest.

According to S&P, a BBB rating indicates “adequate capacity to meet financial commitments, but more subject to adverse economic conditions”. The next step is A, then AA, and finally, AAA, which signifies “extremely strong capacity to meet financial commitments”.

Who stands where

Alongside India, S&P has the likes of Greece, Mexico, and Indonesia at BBB. Just above it, at BBB+, are Botswana (negative outlook), Bulgaria, Italy, Thailand, Uruguay (all stable outlook), and Philippines (positive outlook). A positive outlook puts a rating closer to an upgrade, while a negative outlook makes a downgrade more likely.

Above this, with an A- rating, are countries such as Cyprus, Poland, and Malaysia. And right at the top of the tree, with AAA rating, are the richest countries in the world — Australia, Canada, Denmark, and Germany, among others.

The richest countries are not guaranteed the best rating. Take the US, for instance, which was downgraded to AA+ by S&P in August 2011 — the first time the world’s largest economy had ever been assigned any rating lower than AAA — days after the US Congress raised the country’s debt ceiling. More recently, Moody’s in mid-May lowered its rating on the US to Aa1 from Aaa reflecting “the increase over more than a decade in government debt and interest payment ratios to levels that are significantly higher than similarly rated sovereigns”.

The road ahead

The implications of a better credit rating are clear — the Indian government should be able to borrow at a lower rate of interest. Financial markets are already preparing for this, with government bond yields in the secondary market on August 14 falling as much as 10 basis points, with the rupee’s exchange rate also getting a boost.

Helpfully, S&P said on August 14 that it may further raise India’s rating if the fiscal deficit of the Centre and states falls below 6 per cent of GDP on a structural basis. This, however, is a “tough ask”, according to Arora of Emkay Global. S&P itself expects the combined fiscal deficit to decline only to 6.6 per cent in 2028-29 from 7.8 per cent in 2024-25.