Moody’s cuts India’s rating to lowest investment grade, three key factors that knocked India’s position

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Updated: Jun 01, 2020 8:46 PM

In a major setback, Moody’s today downgraded India’s sovereign credit rating by one notch to ‘Baa3’, while maintaining its negative outlook, citing risks from sustained low growth, among other reasons.

Moody’s warning follows a similar statement by Fitch and is expected to add to policy-makers’ unease, as they firm up a relief package to prop up the economy.‘Baa3’ is the lowest investment grade rating on Moody’s credit rating scale.

In a major setback, Moody’s today downgraded India’s sovereign credit rating by one notch to ‘Baa3’, while maintaining its negative outlook, citing risks from sustained low growth, among other reasons. ‘Baa3’ is the lowest investment-grade rating on Moody’s credit rating scale. “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 on Monday.

The government of India refrained from fiscal expansion while trying to provide economic stimulus and relief to businesses and people struggling against the fallout of the coronavirus pandemic. India’s fiscal spending is limited, even as Prime Minister Narendra Modi unveiled a mega stimulus package with an economic value of nearly Rs 21 lakh crore. Further, the credit rating agency has also downgraded India’s local-currency senior unsecured rating to Baa3 from Baa2, and its short-term local currency rating to P-3 from P-2 while adding that the outlook remains negative.

“Rigid, inelastic & ever-rising pressure on government finances from salaries and interest payments juxtaposed against sharply dwindling taxation revenues leading to persistent missing of medium-term fiscal consolidation targets have proved to be the Achilles heel for India’s economic downgrade by Moodys,” Ajay Bodke, CEO (PMS) Prabhudas Lilladher told Financial Express Online. Bodke added that India’s significantly higher debt burden as compared to peers in the same rating category and escalating vulnerabilities for the extremely fragile, grossly undercapitalized banking & finance sector due to an expected spike in bad loans will continue to weigh heavily on any prospect of rapid economic recovery.

Moody’s said that the negative outlook reflects dominant, mutually-reinforcing, downside risks from deeper stresses in the economy and financial system that could lead to more severe and prolonged erosion in fiscal strength than what is currently projected by the rating agency. India’s fiscal deficit widened to 4.59% of gross domestic product for the financial year 2019-20, going beyond the government’s revised target of 3.8%, according to the data released on Friday. In her Budget speech, Finance Minister Nirmala Sitharaman has pegged the fiscal deficit for 2019-20 at 3.8%, up from 3.3% in the original budget estimate.

“Even though it is a downgrade, the rating is still in investment grade,” said VK Vijayakumar- Chief Investment Strategist- Geojit Financial services. “This is on par with the rating of S&P & Fitch. This is unlikely to impact the market materially since the strength of the market is largely due to the humongous liquidity floating in the global financial system,” he added. While terming it ‘slightly sentiment negative’ VK Vijayakumar stressed on the need for the government to prepare a medium-term fiscal consolidation roadmap to inspire confidence in markets.

Moody’s has upgraded India’s ratings to Baa2 in November 2017 based on the expectation that effective implementation of key reforms would strengthen the sovereign’s credit profile. “Since then, implementation of these reforms has been relatively weak and has not resulted in material credit improvements, indicating limited policy effectiveness,” it said. The stress among the non-banking financial institutions was also highlighted by Moody’s while adding that the stress in the sector may prove to be deeper than what has been assessed. 

“It should provide a dose of sobering reality to equity markets that are punch drunk on a torrent of global liquidity and exuberant about rapid return of aggregate demand in the wake of lifting of lockdown,” Bodke added. 

Moody’s expects the coronavirus shock to cause the debt burden to rise higher still, to about 84% of GDP in fiscal 2020. While it should stabilise at that point, it is unlikely to fall materially thereafter, Moody’s said. While a rating upgrade ‘looks unlikely in the near future’ according to Moody’s, but it added that ratings may be revised to stable if outturns and policy actions were to raise confidence that real and nominal growth will rise to sustainably higher rates than projected. “Commensurate action to halt and reverse the rise in the debt trajectory, even slowly, would also support a stable outlook,” the credit rating agency said. 

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