Moody's Investors Service raised the outlook on India's Baa3 credit rating to "positive" from "stable" on Thursday – becoming the first of the three major ratings agency to upgrade its view.
The revision was based on the perception that India's policymakers are establishing a framework that will improve India's "macro-economic, infrastructure and institutional profile", allowing the economy to outperform its peers over the medium-term.
"There is an increasing probability that actions by policy makers will enhance the country's economic strength and, in turn, the sovereign's financial strength over coming years," Moody's said.
Peers Standard and Poor's and Fitch Ratings rate Indian credit at the lowest investment grade, in line with Moody's rating, but with a "stable" outlook.
Investors reacted positively to the move, with the benchmark S&P BSE Sensex rising 0.5 percent at the start of trade.
Efforts paying off
Recent measures to address inflation, keep external balances in check, simplify the regulatory regime for investors, increase foreign direct investment, and facilitate infrastructure development will reduce some of India's sovereign credit constraints, Moody's said.
"Many of these measures are at relatively early stages of design and have yet to be implemented. The ability of policymakers to strengthen India's sovereign credit profile to a level consistent with a higher rating will become apparent over the next 12-18 months," it said.
Economists say the outlook upgrade is encouraging and comes as a positive surprise.
"The timing of the outlook change is surprising given that the central government pushed out its medium-term fiscal consolidation path by a year in the recent budget, while our analysis of recent state budgets suggests no fiscal consolidation on a general government basis," said Sonal Varma, chief India economist at Nomura.
"However, we agree that India's economic fundamentals are improving with the government focused on boosting investment and productivity and the Reserve Bank of India focused on keeping inflation low. This policy combination should ensure growth with macro stability in the coming years and should make India stand out relative to its peers," she said.
Set for an upgrade?
Vishnu Varathan, economist at Mizuho Bank says the move sets the stage for an overall ratings upgrade. A ratings upgrade is significant because it would likely reduce the nation's borrowing costs.
"The outlook upgrade in its self is positive but the comments that followed are equally encouraging," said Varathan.
"Markets will be watchful of further signs of investments picking up and fiscal consolidation in looking for a ratings upgrade trigger."
In its statement, Moody's said evidence of further efforts to introduce "growth-enhancing and growth-stabilizing economic and institutional reforms" would lead to the rating being considered for an upgrade.