Reticent global investors are likely to join the party in Indian equities after a top rating agency delivered a ringing endorsement of New Delhi’s policy initiatives and affirmed growth would rebound over the medium to longer term. It should provide renewed thrust to the bullish fervour that has propelled benchmark indices to all-time highs.

Moody’s Investor Service upgraded India’s credit rating for the first time in almost 14 years, raising it one notch in the investment grade, saying fiscal prudence and reforms undertaken by the government will provide a thrust to the growth engine in the coming yeaRsUndoubtedly, it was the biggest vote of confidence for Prime Minister Narendra Modi’s administration, which is fighting provincial elections in his home state of Gujarat.

The elevation also gives a stamp of approval to a controversial demonetisation drive, which caused severe hardships to large sections of the population and hit businesses across the country. The decision in November 2016 to scrap high-value bank notes that comprised a staggering 86 per cent of the currency in circulation, disrupted economic activity and was the primary reason for growth to slump to a 3-1/2 year low in the June quarter.

Teething problems with the launch of a Goods and Services Tax (GST) in July have also dented growth. However, both the measures are expected to have a beneficial effect over the longer term when bulk of the businesses move into the formal economy, remove bottlenecks such as barriers to movement of goods from one state to another, boost tax compliance and bolster government revenues.

“The decision to upgrade the ratings is underpinned by Moody’s expectation that continued progress on economic and institutional reforms will, over time, enhance India’s high growth potential and its large and stable financing base for government debt, and will likely contribute to a gradual decline in the general government debt burden over the medium term,” the global rating agency said in a statement.

Early Christmas

Doubtlessly, the upward revision will be music to the bulls. Foreign funds that have stayed aloof because of frothy valuations and slower earnings growth will have to rethink their strategy. Cash-flush domestic institutions have been the main driver of stocks this year, lifting benchmark indices by more than a quarter in 2017.

The rally to a series of record highs had caused unease among some investors, and it was expected that large players would be looking to unwind their positions before the holiday season. Moody’s move could bring in a new perspective.

“With the ratings upgrade, the mood of the markets will swing from fear to greed,” HDFC Securities said.

Seasoned investors are not hiding their glee at the early arrival of Santa Claus.

“This upgrade is also in recognition …. the direction which the government is undertaking is going to lead to higher economic growth, and it is also a befitting reply to critics of Modi government,” billionaire investor Rakesh Jhunjhunwala, who believes the bull run has only begun, told CNBC-TV18.

The immediate impact of the improved rating would be a drop in risk premiums that Indian companies have to pay for loans abroad. Besides lowering interest burden companies should feel encouraged to taken on new projects that will become handy when growth accelerates.

“A large part of capital allocation are ratings-led,” noted Chanda Kochhar, CEO of ICICI Bank. “It leads to lower credit premium for corporates and makes capital cheaper. Some more pension funds will now be able to invest in India.”

Moody’s expects GDP to expand 6.7 per cent in the current financial year to next March, down from 7.1 per cent in the previous year, and then to rebound to 7.5 per cent in 2018-19. Jhunjhunwala, who is often called India’s Warren Buffett, sees growth reaching 7.5-8.0 per cent next year and wants investors to keep a close eye on a pickup in investment.

“In 2002-03 the ratio of investment to GDP was 26-27 per cent, it went up to 35-36 per cent in 2008. I expect that kind of cycle. If the ratio goes up to 34-35 per cent, that itself would add 100-150 basis points to the GDP,” he told the television channel.

Hefty gains in indices

The top-30 Sensex, which hit a record high of 33,865.95 on November 7, closed at 33,342.80 on Friday, gaining 25.2 per cent in 2017. The broader 50-share Nifty has climbed 25.6 per cent this year to 10,283.60, off its all-time peak of 10,490.45 reached on November 6.

The contribution of foreign funds to the gains is minuscule. According to data from the BSE, foreign portfolio investors were net buyers of shares worth a measly Rs2.156 billion between April and October, largely caused by net outflows of about Rs242 billion over August and September. In comparison, net inflows in the full financial year that ended in March 2017 were Rs686.856 billion.

On the other hand, foreign flows into debt have soared, lured by high real interest rates even as inflation cooled. Foreigners bought debt worth Rs1.177 trillion during April to October, in a reversal of trend after net outflows of Rs149.23 billion in 2016-17, the data showed.

Because of caps on foreign investment in debt, there is not much scope for further inflows there save corporate bonds. But the field is open for equities, and funds who have missed out on the rally so far may want to get a foot in before the market builds up more steam in the run up to 2018.

The Moody’s upgrade lifts India above South Africa among the emerging markets group BRICS to the second spot behind China.

Sensex rejig

The BSE will replace two drugmakers in the Sensex with two private-sector lenders, taking the number of the banks in the benchmark 30-share index to seven. It reflects the increasing importance of banks in the economic activity, while pharmaceuticals face stronger headwinds from lucrative generic markets such as the US.

Effective December 18, IndusInd Bank and Yes Bank will become constituents of the widely tracked Sensex, raising their investor profile. Being part of the benchmark should encourage more funds to buy the stocks.

The two stocks will take the place of Cipla and Lupin Ltd that will be removed from the same date. Only two drugmakers, Dr. Reddy’s Lab and Sun Pharma, remain in the index.

The BSE, Asia’s oldest stock exchange, periodically rejigs the constituents of its indices to make them representative of the happenings around. It has also made changes to many sectoral and broader indices.

The author is a journalist based in India.