US—based Moody’s has a caveat before considering a rating upgrade for India — the country should stick to fiscal consolidation and effectively address weaknesses in the banking sector.

“If policies reduce the supply constraints on growth via infrastructure and regulatory improvements, sustain the improvement in inflation and external metrics, continue along the path of fiscal consolidation and address banking sector weaknesses, India’s sovereign credit profile is likely to improve,” Moody’s sovereign rating analyst Atsi Sheth told PTI in an interview.

The rating agency had last week raised India’s outlook to ’positive’ from stable and said there was a probability of a rating upgrade in the next 12—18 months.

India’s sovereign rating by Moody’s stands at ‘Baa3’, the lowest investment grade and just a notch above the ‘junk’ status while it earlier had a ‘stable’ outlook for the country.

Replying to queries on the banking sector, Sheth said there are challenges with regard to asset quality.

“Should banking system asset quality and capitalisation levels improve materially from the current levels, the risks banking sector challenges pose to the sovereign credit profile will likely decline,” she said.

The rating upgrade by an agency is generally associated with improvement in fundamentals like fiscal consolidation, implementation of reforms and external sector stability.

The rising bad loans have become a major worry for the Reserve Bank as well as the government.

Most of the restructured loans are from the corporate sector. The top 30 defaulters are sitting on bad loans of Rs 95,122 crore, more than one—third of the gross non—performing assets of PSU banks at Rs 2,60,531 crore as of December 2014.

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