Moody’s Investors Service on Monday downgraded India’s sovereign rating one notch to the lowest investment grade (Baa3) with negative outlook, holding that Asia’s third largest economy faces a prolonged period of slower growth relative to the country’s potential amid rising debt and persistent stress in parts of the financial system.
“The decision to downgrade India’s ratings reflect Moody’s view that the country’s policymaking institutions will be challenged in enacting and implementing policies which effectively mitigate the risks of a sustained period of relatively low growth, significant further deterioration in the general government fiscal position and stress in the financial sector,” it said.
India’s fiscal deficit in FY20 expanded to 4.6% of GDP against the budgeted 3.8% of GDP. Mint on Sunday reported that the country’s fiscal deficit in FY21 may breach the level of 6.4% of GDP, last seen in the aftermath of the global financial crisis in FY10. India’s economic growth in the March quarter decelerated to an 11 year low at 3.1% partially reflecting the ongoing nationwide lockdown with fresh data suggesting a sharp contraction in GDP in the June quarter of FY21.
The rating agency said the negative outlook reflects dominant, mutually-reinforcing, downside risks from deeper stresses in the economy and financial system that could lead to a more severe and prolonged erosion in fiscal strength than Moody’s currently projects.
To be sure, Moody’s was always a notch above other rating agencies assessing India’s sovereign rating and hence had a greater risk of downgrade. Both Fitch Ratings and Standard & Poor’s have the lowest investment grade rating with stable outlook for India at present.
Fitch Ratings and Moody’s had in April warned that deterioration in India’s fiscal outlook as a result of lower growth could put pressure on its sovereign rating. Fitch had said its assessment of India’s rating in such a scenario would be guided by its judgment of the country’s probable medium-term fiscal path in the post-crisis environment.
Moody’s said it had upgraded India’s ratings to Baa2, the second lowest investment grade, in November 2017 based on the expectation that effective implementation of key reforms would strengthen the sovereign’s credit profile through a gradual but persistent improvement in economic, institutional and fiscal strength. “Since then, implementation of these reforms has been relatively weak and has not resulted in material credit improvements, indicating limited policy effectiveness,” it added.
Moody’s said although a rating upgrade is unlikely in the near future, it would change the outlook on India’s rating to stable if outturns and policy actions were to raise confidence that real and nominal growth will rise to sustainably higher rates than Moody’s projects, including through measures which enhance financial stability by strengthening the supervision, regulation and capitalization of the financial sector. “Commensurate action to halt and reverse the rise in the debt trajectory, even slowly, would also support a stable outlook. Further evidence that self-reinforcing economic and financial risks are rising would put downward pressure on the rating,” it added.
The rating agency said while the latest rating action is taken in the context of the coronavirus pandemic, it was not driven by the impact of the pandemic. “Rather, the pandemic amplifies vulnerabilities in India’s credit profile that were present and building prior to the shock, and which motivated the assignment of a negative outlook last year,” it said.
Moody’s also revised its FY21 GDP estimate for India to 4% contraction against 0% growth projected earlier, citing shock from the coronavirus pandemic related lockdown measures. However, it hopes for a V-shaped recovery with economic growth projected to pick up at 8.7% in FY22 and 6% thereafter.
“Thereafter and over the longer term, growth rates are likely to be materially lower than in the past, due to persistent weak private sector investment, tepid job creation and an impaired financial system. In turn, a prolonged period of slower growth may dampen the pace of improvements in living standards that would help support sustained higher investment growth and consumption,” the rating agency cautioned.
While the government responded to the growth slowdown prior to the coronavirus outbreak with a series of measures aimed at stimulating domestic demand, and recently announced a support package aimed at supporting India’s most vulnerable households and small businesses, Moody’s said it does not expect that these measures will durably restore real GDP growth to rates around 8%, which had seemed within reach just a few years ago.