Large stimulus may attract rating cut: Experts

The markets are eagerly awaiting a stimulus package, but they are also trying to second-guess if the resultant widening of the fiscal deficit would adversely affect the country’s rating.

Global rating agencies S&P and Fitch have India’s ratings at BBB-, one notch above junk. But Moody’s has India’s rating at Baa2, one notch above its equivalent in S&P and Fitch. Moody’s had lowered India’s rating outlook to ‘negative’ in November 2019. The core contention seems to be that India’s general government debt, or the debt of the Centre and states combined, is over 70 per cent of GDP already.

And this, according to the International Monetary Fund (IMF), does not give much scope for India to come out with a hefty stimulus package. So far, India has infused 0.8 per cent of GDP as stimulus, but that is tiny in comparison with the United States’ 10 per cent.

“India is not a country with ample fiscal space,” said Vitor Gaspar, director, fiscal affairs department, IMF, while releasing its Fiscal Monitor report in mid-april. “But a health emergency takes precedent and the fiscal support needed is quite substantial, but it is temporary.”

But such a stimulus has not come yet, and market participants such as Jayesh Mehta, country treasurer at Bank of America Merrill Lynch, are expecting that such a measure can come only when the lockdown is lifted. There are now expectations that the stimulus should be at least 2-3 per cent of GDP, which would push the fiscal deficit to 10-10.5 per cent.

That is a red zone for the rating agencies, even as they are mindful of a necessary fiscal expansion due to Covid-19.

Rating agency S&P, in a note released on April 16, had said any sovereign rating action would not be influenced automatically by the slowdown and the fiscal situation arising due to Covid-19, the disease caused by coronavirus.

While the negative dynamics may lead to the conclusion that such shocks must lower sovereign ratings across the board, the ratings would go beyond the headline items, S&P had assured. It said it saw the slowdown as temporary.

“Our sovereign criteria are designed to allow ratings to withstand shortterm fluctuations within different economic cycles. The analytical judgment we use in evaluating the different characteristics of each sovereign, including its room to maneuver and the policy flexibility it possesses to defend the economy, is an important factor in our analysis of such fluctuations,” the agency had said.

The rating agency did not specifically mention India. In fact, it responded to a Business Standard query on the issue, saying, “we do not comment on the timing of our reviews or speculate on any potential future changes to ratings”. Fitch and Moody’s did not respond to Business Standard queries on the issue.

Despite the elbow space being considered by the rating agencies, economists are already betting on a potential rating downgrade for India, at least from Moody’s. “There is a rising risk of an imminent downgrade by Moody’s (to Baa3 ‘stable’ from Baa2 ‘negative’), bringing it on a par with S&P and Fitch, both of which rate India at BBB-,” wrote Nomura analysts Sonal Varma and Aurodeep Nandi in a note on April 29.

“We also see a risk that Fitch will change India’s outlook to ‘negative’ due to deteriorating debt dynamics and its assessment that India has a poor fiscal track record. Meanwhile, S&P’S assessment appears hinged on institutional factors that may change more slowly,” according to Nomura.

“India’s Achilles heel on ratings,” Nomura analysts noted, “is its parlous state of fiscal affairs and the risk of a sharp deterioration of general government debt from 70 per cent of GDP to potentially 75-80%.”

DBS economist Radhika Rao raised a similar concern on the rising deficit. However, some of the fiscal concerns can be addressed by the rise in taxes on petrol and diesel.

The core contention seems to be that India’s general govt debt, or the debt of the Centre and states combined, is over 70% of GDP already