The agency, which put India a notch above peers' ratings in Nov 2017, now cites possibility of sustained period of relatively low growth and fiscal deterioration
Moody’s Investors Service on Monday trimmed India’s sovereign rating by a notch to the lowest investment grade of Baa3 and retained the “negative” outlook, giving effect to earlier warnings of a downgrade if the country’s fiscal metrics “weaken materially” in the wake of the Covid-19 pandemic.
Since the agency had warned of downgrade on May 8, the Centre unveiled an economic stimulus package of close to Rs 21 lakh crore (barely 10% of which was additional budgetary cost), the National Statistics Office announced the country’s GDP growth slowed to an 11-year low of 4.2% in FY20 and the Centre’s fiscal deficit in FY20 was revealed to be 4.6% of GDP, the highest level since FY13.
The fiscal deficits of both the Centre and states are expected to rise substantially in FY21, given the economic slump and continued reliance on government spending to revive the economy and meet the extra spending obligations related to Covid-19.
“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,” the agency said in a statement.
Moody’s was the only agency to revise up India’s sovereign rating for the first time in over a decade in November 2017, while its peers — S&P and Fitch — haven’t yet given the country an upgrade. It then cited expectations of “continued progress on economic and institutional reforms” which could enhance the country’s growth potential.
Later, in November last year, it revised down its outlook for the country to negative. However, with Monday’s downgrade, Moody’s rating of India remains the same as others, while its outlook is worse than theirs. Of course, S&P and Fitch haven’t yet announced their latest rating actions.
Its 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”, the agency said.
Moody’s 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. The outlook remains negative.
While the rating action wasn’t entirely unexpected (others, analysts fear, may soon trim their outlook to negative as well), some economists have already discounted such apprehensions, saying that unprecedented crises warrant elevated government spending to rekindle growth impulses fast and fiscal hawkishness is best suited for normal times. Also, it will be interesting to see how they rate other countries, including the developed ones that are estimated to face a much sharper growth contraction in India with rising debt-to-GDP levels, they have said.
Recently, Thomas Rookmaaker, director (Sovereign Ratings) at Fitch Ratings, told FE: “The projected medium-term fiscal path after the pandemic will play an important role in our assessment of India’s sovereign rating. We expect government debt to rise in FY21 and FY22, but the government may tighten fiscal policy again once the pandemic is under control.”
Rookmaaker had also said Fitch would factor in the fiscal buffers that sovereigns had going into the crisis. “In India’s case the fiscal buffers are small, but the external finances are resilient relative to many of its peers. India’s economy is relatively closed in nature and the RBI has strengthened its foreign exchange reserves in recent years.” Weakening financial sector could also weigh on rating action.
India’s debt-to-GDP ratio, according to Moody’s, rose to 72.3% in FY20, against 69.9% a year before.
The RBI has projected negative growth for FY21 without giving a specific estimate, while some private analysts have warned of real expansion slipping to as low as -6.8%. This will severely dent finances of the centre and states.
Commenting on fears of a massive spike in India’s debt levels, a sore point with rating agencies, M Govinda Rao, member of the Fourteenth Finance Commission, last week said: “Debt-to-GDP ratio will go up everywhere. So the appraisal of the relative performance of India vis-a-vis other countries will be crucial. A great lesson in macro-economy is that in times of great depression, governments need to borrow and spend. I don’t think rating agencies are oblivious to this fact. Even if they downgrade, so what?”
According to the recently revised Centre’s borrowing programme, the estimated fiscal deficit for FY21 stands at 5.7% of GDP, according to DK Srivastava, chief policy adviser at EY India. “This may not be enough to cover both the shortfall in Centre’s budgeted tax revenues and the already announced fiscal stimulus. If there is no expenditure compression, Centre’s fiscal deficit may need to be increased to about 7% of GDP. The state governments have also been allowed, subject to certain conditions, to enhance their borrowing from 3% to 5% of their respective GSDPs. Together with the borrowing requirements of public sector undertakings of 3.5% of GDP, this adds up to 15.5% of GDP,” he wrote.
SBI economists have estimated the general government fiscal deficit to be 13.3% (8.3% for Centre and 5% for states) in FY21. As per Care Ratings, combined fiscal deficit of the Centre and states can be in the region of 11-12% in FY21.
According to the FRBM mandate, the Centre’s fiscal deficit is to be 3% of GDP, however, that has eluded in the past decade with resetting of target multiple times. The fiscal deficit is now pegged to be 3.5% in FY21, before coming down to 3.1% in FY23. Obviously, these figures will have to revised steeply now.
“Measures to improve India’s fiscal strength, which were at the heart of the government’s policy framework a few years ago, have underwhelmed. Fiscal performance in recent years has been weaker than expected, with fiscal deficit targets consistently missed and a persistent lack of clarity on how medium-term fiscal consolidation objectives would be achieved,” Moody’s wrote.
Moody’s expects India’s real GDP growth to contract by 4% in FY21 due to the shock from the coronavirus pandemic and related lockdown measures, followed by 8.7% growth in the next fiscal and closer to 6% thereafter. The country’s growth dropped from a high of 8.3% in FY17 to 4.2% last fiscal. It forecasts the country’s debt burden to rise to about 84% of GDP in FY21, indicating the fiscal stress. As such, at 72% of GDP in the last fiscal, India’s general government (combined Central and state governments) debt burden was 30 percentage points larger than the Baa-median, even before the pandemic, the agency said.