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Moody's India Rating Downgrade to Baa3 Explained

Jun 2, 2020 1:18 PM 5 min read
Editorial

Moody's Investors Service on Monday downgraded India's sovereign rating to Baa3 from Baa2, placing it just one notch above a non-investment grade or junk grade, and maintaining its ‘negative’ outlook.

“The decision to downgrade India’s ratings reflects 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,” Moody’s said in a statement.

The rating agency also 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.

A downgrade so close to the bottom fringe of investment grade has come almost 22 years after Moody’s last lowered India’s rating to Ba2 (non-investment grade) on June 19, 1998 in the aftermath of the country’s nuclear tests.

We discuss what the downgrade means and what its implications might be on the Indian economy. 

 

 

Why Did Moody's Downgrade India's sovereign rating to Baa3 from Baa2?

The latest downgrade brings Moody’s ratings for India in line with the other two major rating agencies in the world - Fitch and S&P.

FYI, Moody’s has historically been the most optimistic about India (seen from the chart below) For a quick review of Moody’s ratings framework, here’s a primer

 

Moody's rating for India (historical data)

 

Moody’s has primarily stated four reasons for the downgrade.

1. Weak implementation of economic reforms since November 2017.

Moody’s had, in November 2017, upgraded India's ratings to Baa2 based on the expectation that effective implementation of key reforms, including the implementation of the bankruptcy reforms and the implementation of the GST regime, would strengthen the sovereign's credit profile. However, that optimism soon waned, with the ratings agency changing its outlook for India from stable to negative in late 2019. “Since then, implementation of these reforms has been relatively weak and has not resulted in material credit improvements, indicating limited policy effectiveness,” the agency said.

2. Relatively low economic growth over a sustained period.

India’s GDP growth slowed to 3.1% in Q4, pulling down the number to an 11-year low of 4.2% for FY20.

In another set of data released, eight core sector output contracted 38.1% in April.

The Indian economy had begun slowing last year but a countrywide lockdown to contain the spread of the coronavirus outbreak halted economic activity almost completely. The full impact of the lockdown on manufacturing and services will become more pronounced in the June quarter.

Economists expect the fiscal year that began in April to see the worst economic contraction in at least four decades. As per estimates by Bank of America Securities, India GDP may contract by 2% in FY21. Moody’s also revised its FY21 GDP estimate for India to 4% contraction against 0% growth projected earlier.

3. A significant deterioration in the fiscal position of Central Government and State Governments.

India's fiscal deficit for FY20 stood at 4.6%, significantly higher than its revised target of 3.8% set in February.

Moreover, weighed down by higher expenses on the back of the pandemic and the need to boost the economy coupled with forecasts of subdued revenue collections, the Government recently said it will borrow about ₹12L cr from the market in FY21, a 54% jump over the Budget estimate of ₹7.8Lcr.

Officials expect the fiscal deficit for the current fiscal year to rise to as much as 5.2-5.5% of the year’s GDP, up from the targeted 3.5%.

4. Rising stress in India’s financial sector that has been reeling from one crisis after another.

First the bad loan debacle, then the shadow-banking mess with demonetisation acting as grease, and now more bad loans thanks to COVID-19 related stress.

As per Credit Suisse, some 15%-75% of bank loans and 30%-75% for NBFC loans are under COVID-19 induced moratorium. Credit performance is only expected to deteriorate in the immediate future, which as per their estimates would lead to almost $20bn of recapitalisation needed by the Indian banking system.

 

moodys india rating downgrade

 

What will be the Implications of this Downgrade on the Stock Market and the Indian Economy?

Ratings are based on the overall health of the economy and the state of government finances. 

A downgrade in rating would mean that bonds issued by the Indian Government are now “riskier” than before, because weaker economic growth and worsening fiscal health undermine a Government’s ability to pay back.

Needless to say, lower risk is better because it allows Governments and companies of a country to raise debts at a lower rate of interest.

Interestingly, however, economists and experts don’t think Moody’s downgrade will have a major effect on markets, as the new rating is on a par with the S&P’s and Fitch ratings of India at BBB-. The “negative” outlook could however sway the sentiment in the short term.

This downgrade was impending and is somewhat largely priced-in by the markets and any knee-jerk reaction in foreign exchange and rates markets would thus likely be short-lived, Madhavi Arora, Economist, Edelweiss, said in a report.

The rating downgrade is also less likely to affect the cost of India’s borrowings as a large part of sovereign debt is locally-held. Foreign portfolio investors hold merely 3.3% of total outstanding government securities, Madhavi added.

 

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