Have GST Rate Cuts Capped India’s Credit Rating Prospects?

On the eve of India’s 79th Independence Day, the country scored a long-awaited milestone. Standard & Poor’s (S&P) Global Ratings, one of the big three credit rating agencies, upgraded India’s sovereign credit profile for the first time in 18 years, raising the long-term rating to ‘BBB’ from ‘BBB-’ and the short-term to ‘A-2’ from ‘A-3’, both with a stable outlook.

The very next day, Prime Minister Narendra Modi stood at the Red Fort and promised a sweeping reform of the Goods and Services Tax (GST), calling it a “big and bold” step for the common man. By evening, finance ministry officials revealed what the Centre had in mind. It aimed to collapse the four-tier GST structure into just two slabs, with a special rate for luxury and sin goods. Most items would see their rates cut; only a handful would go up.

A week later, however, came a note of caution. Fitch Ratings, another of the big three, chose to hold India’s rating at ‘BBB-’, citing robust growth and solid external finances but pointing to the government’s stretched balance sheet as a “credit weakness.” It warned that while the GST overhaul could support growth, it might also prove “slightly revenue-negative.”

And now, with the GST Council having unanimously cleared the reform, Moody’s, the final third, has joined the conversation. Earlier this year, it had kept India at ‘Baa3’, the lowest investment grade. This time, it described the reform as “revenue-eroding," warning that government spending growth is likely to slow over the next two quarters as New Delhi works to preserve its fiscal consolidation path. It believes that the revenue foregone would be higher than the government's estimate of ₹48,000 crore.

“The strain will be even more pronounced in the coming years,” Moody’s said in a recent report, “because the new tax structure will be effective over a full year, rather than just the remaining six months of the current fiscal.”

Together, the three verdicts raise a larger question: was S&P’s upgrade the start of a sustained positive credit trajectory for India, or just an isolated one-off?

The Weight of Ratings

Credit rating agencies assess government debt on a consolidated basis, that is, the Centre plus the states. Many Indian economists argue that the ratings they assign do not fully reflect India’s macroeconomic fundamentals. Still, no one denies their influence. “The low ratings may not constrain the volume of capital, but they certainly result in higher cost than would be the case otherwise,” says TT Ram Mohan, part-time member of the Economic Advisory Council to the Prime Minister.

The Finance Ministry itself has made the point. In a December 2023 paper, it noted that India’s sovereign rating had “remained static” at ‘BBB-’ for 15 years, even as the country rose from being the world’s 12th largest economy in 2008 to the 5th largest in 2023. “This has serious implications for developing sovereigns’ access to capital markets and ability to borrow at affordable rates,” the paper, authored by economists led by the Chief Economic Adviser, observed.

S&P’s nod to India was driven by the country’s strong growth and steady fiscal consolidation after the Covid-19 shock. “It (India) staged a remarkable comeback from the pandemic with real GDP (gross domestic product) growth over fiscal 2022 to fiscal 2024 averaging 8.8%, the highest in Asia-pacific. We expect these growth dynamics to continue in the medium term, with GDP increasing 6.8% annually over the next three years,” S&P analysts said in a statement.

Credit rating agencies typically base their assessments on a mix of economic, institutional, external, fiscal, and monetary metrics. Yet how they weigh these factors to arrive at a final rating remains opaque, a point India has often raised in its engagements with them. What Fitch and Moody’s recent commentaries make clear is that their reluctance to follow S&P’s lead has much to do with India’s fiscal profile.

Fiscal Face-Off

After the GST Council cleared the Centre’s proposal to overhaul the tax regime and reduce rates on September 3, Finance Minister Nirmala Sitharaman began her press briefing around 10 pm, happy to begin by saying that the proposal had been unanimously approved. Yet media reports quickly began to surface, reflecting states’ concerns over potential revenue losses and demands for compensation. Several states, including Jharkhand, Punjab, and Kerala, insisted that their consent was given only in the interest of the common man, and that they would need to be adequately compensated for the fiscal shortfall.

So it is not just Moody’s and Fitch that are cautious about the revenue impact of the GST reforms, states themselves, despite consenting to the proposal, have voiced concerns. The Centre, however, maintains that these negative estimates are premature and that the potential trade-off with improved compliance and stronger long-term revenue growth should be considered.

“Whatever revenue implication figures are coming out in the media from different stakeholders, ultimately that money is going to be placed in the hands of consumers. Once it remains in the economy, it will be spent again, creating multiple cycles,” Sanjay Kumar Agarwal, Chairman of the Central Board of Indirect Taxes and Customs told Outlook Business in a recent interview. “When consumption goes up, economic activity increases, jobs are created, the economy grows, GDP grows. That is the way the country progresses. It stimulates growth.”

Kerala’s Finance Minister KN Balagopal disagrees. He argues that almost all states are likely to face a revenue squeeze and warns that unless the Centre address potential shortfalls, the broader economy could take a hit. While economic theory, and the Centre, suggests that tax cuts should spur consumption and improve revenue buoyancy, he notes that the actual outcome will depend heavily on state-specific spending patterns.

Many economists remain skeptical about the GST reforms’ impact on public finances, especially coming on the heels of an unprecedented income tax cut, from ₹7 lakh to ₹12 lakh per annum, announced in this year’s Budget. How much revenue the reforms actually generate, they feel, will depend largely on how households respond, particularly those still grappling with stagnant wages and high post-Covid debt. Arvind Subramanian, who served as Chief Economic Adviser during the GST’s conception, estimates the annual revenue foregone at between ₹1.5 lakh crore and ₹2.1 lakh crore. “This loss could have serious consequences for long-term macroeconomic and fiscal stability,” he warns, alongside co-authors Josh Felman and Abhishek Anand in The Economic Times.

In that case, it will be interesting to see whether credit rating agencies view the GST reforms as a step toward long-term fiscal strength or as a move that erodes revenue and strains public finances. With S&P having already upgraded India, Fitch and Moody’s holding back, and states signaling distress, the coming months could reveal whether India’s recent rating milestone marks the start of a sustained positive trajectory, or remains a solitary achievement in an otherwise uncertain fiscal landscape.