Downgrading of India’s credit rating and outlook by Moody’s

Yesterday, credit rating agency Moody’s downgraded the Indian government’s local & foreign currency long-term issuer ratings to Baa3 from Baa2, while maintaining the outlook of the economy as “Negative”. This is the first time in 22 years that India’s sovereign credit rating has been downgraded. Moody’s further estimated that the GDP for the current fiscal is likely to shrink by 4% – the first full contraction in more than four decades. India’s local currency senior unsecured rating too has been downgraded from Baa2 to Baa3 while it’s short term local currency rating has been lowered to P-3 from P-2. Baa3 is the lowest investment grade – only a level above “junk” grade.

Back in November 2017, Moody’s had upgraded India’s rating to Baa2 with a “Stable” outlook. Last year in November, Moody’s had changed the outlook to “Negative” while maintaining the Baa2 rating. But now, the credit rating agency has also downgraded the rating to the lowest level of investment ratings. It brings Moody’s rating at par with those of the other two major credit rating agencies: S & P and Fitch which both rate at India at BBB(-) and project the economy to shrink by 5% in the current fiscal period.

Key reasons for this downgrade in ratings:

Moody’s has categoricaly stated that the downgrade in ratings is not an outcome of the blow of the covid19 induced lockdown but rather in context of the same. In Nov’17, when Moody’s had upgraded India’s rating to Baa2 with a “Stable” outlook, the same was on the expectation that “effective implementation of key reforms would strengthen the sovereign’s ‘credit profile’ through a gradual but persistent improvement in economic, instituitonal and fiscal strength”. However, the expectations set more than two years ago have not been met with slow implementation of said reforms resulting in the downgrading of the rating. Additionally, the other factors that have played a role in this action include:

  • Relatively low economic growth for a prolonged period of time
  • Signficant weakening in fiscal positions of both central and state governments
  • Growing stress in India’s financial sector

The Indian economy was already showing signs of a slowdown even before the covid19 pandemic hit. Gross Fixed Capital Formation (GFCF), an indicator of investment actvity, is projected to contract by 2.8% in FY19-20 as compared to growth of 9.8% in FY18-19. Growth in manufacturing and construction – two of the most people intensive sectors – stand at 0 and 1.3% in FY19-20 vis-a-vis growth of 5.7% and 6.1% in the previous FY. Private consumption slowed down to 5.3% from 7.2% a year before. Undoubtedly, al these had an impact on Moody’s assessment and decision.

In it’s official statement, Moody’s has stated that slow reform momentum and constrained policy effectiveness have contributed to a prolonged period of slow growth (vis-a-vis expectations and India’s potential) that started before the onset of the covid19 pandemic and one which the agency expects to continue even after the pandemic recedes. India is currently witnessing the sharpest contraction in it’s GDP growth – the provisional figure for FY19-20 stands at 4.2%, the lowest in a decade – with the prospect of this number getting further downward revised. The government finances – both center and state – are also in unhealthy state. Even before the onset of the pandemic, Moddy’s estimates that India’s general government debt burden (central + state) stood at 72% of GDP in the FY18-19 – 30 p.c. points higher than the Baa median. This already high number is further expected to rise to approx 84% in FY19-20 as government borrowing has continued to increase.

What are the implications of this action?

The credit rating is an indicator of the state of health of the economy and also the state of the government finances. A rating downgrade implies that bonds issued by the government become more risky because weak growth and deteriorating fiscal health undermines a goverment’s ability to payback. In other words, it will become more expensive for both the goverment as well as Indian corporates to raise loans since India will now be viewed as a riskier investment destination.

On the other hand, a 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 currenrly projects. In other words, a “negative” rating means that India’s credit rating could be downgraded further.

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