THE LOSS OF FAITH
On June 1, Moody’s Investors Service, which rates bonds issued by governments and commercial entities, downgraded India’s foreign-currency and local-currency long-term issuer ratings by a notch to ‘Baa3’ from ‘Baa2’, adding that the outlook remained ‘negative’. This is the lowest investment-grade rating in Moody’s assessment. Bond credit ratings represent the creditworthiness of corporate or government paper.
The reasons Moody’s cited for the downgrade are: weak implementation of economic reforms since 2017, relatively low economic growth over a sustained period, a significant deterioration in the fiscal position of governments (central and state) and the rising stress in the country’s financial sector.
Moody’s downgrade of India’s sovereign rating to Baa3 brings its rating in line with Standard &Poor’s (S&P) and Fitch’s ratings (BBB-), a notch above ‘junk’ status. This comes after Moody’s outlook downgrade to ‘negative’ in November 2019, which it has still maintained, while S&P and Fitch currently have a ‘stable’ outlook for India.
“We think the Moody’s downgrade was impending and is largely priced in by the markets,” says Madhavi Arora, lead economist with Edelweiss Securities. “Any knee-jerk reaction in forex and rates markets would thus likely be short-lived.” Indeed, the stock markets ignored the ratings action, as a downgrade was already expected. In fact, on June 2, the benchmark Sensex rose 522 points to touch 33,826 on the Bombay Stock Exchange on the back of positive sentiment across global
markets as economies opened up after a prolonged lockdown.
The bigger risk, according to Arora, is a potential downgrade from S&P and Fitch. “Their downgrade to ‘junk’ could be a bigger risk [for markets], but this would first involve their outlook moving to ‘negative’ from the current ‘stable’, which generally comes with a big lag,” says Arora. Madan Sabnavis, chief economist of Care Ratings, says that the timing of the downgrade “is a bit odd” because of the extraordinary situation prevailing in many countries. However, the government needs to look into the concerns raised by the rating agency. “The Indian government is not affected because it does not borrow from the overseas market. It is a reputation issue. But for Indian companies that borrow in the external commercial borrowings market, the cost of funding will go up,” Sabnavis says.
The downgrade came close on the heels of the GDP numbers for the fourth quarter of fiscal 2020. Growth slowed to 3.1 per cent in Q4, a low not seen in more than 17 years, with private investment and manufacturing hit hard. The slowdown was significant, considering the fact that the impact of the Covidinduced lockdown was felt for only a few days in March. This indicates that factors other than the lockdown were responsible for pulling down growth. These factors have not gone away, and will continue to weigh on growth prospects, over and above the disruption caused by the lockdown.
The downgrade by Moody’s points to some of these deep-rooted issues. Already, growth had been tottering in the past few quarters. In the third quarter of fiscal 2020, India’s GDP grew at 4.5 per cent, compared to 4.8 per cent in the second quarter. But in the fourth, things went from bad to worse. ‘The overall pace of growth weakened across key sectors in Q4 of fiscal 2020,’ says Care Ratings in a report. The government sector was seen to be propelling overall economic output and demand during the quarter, and had acted as a buffer against the low growth in other sectors like manufacturing and construction, which went into the negative zone. One of the key issues that India has seen in recent quarters is a slackness in demand. Most of the measures the government has resorted to in recent times (including what was announced in the Union budget) have been on the supply side. There is no appetite to either invest or to spend. Private consumption, which is said to be the driver of the economy (accounting for 60 per cent of GDP), declined to 2.7 per cent in the fourth quarter of fiscal 2020 from 6.2 per cent in the same quarter a year ago. Investments witnessed a sharp contraction of 6.5 per cent in the fourth quarter. ‘This portends worsening economic conditions for the domestic economy in coming months in the event of failure to contain the spread of the virus in the country,’ the Care Ratings note adds. However, government spending helped, and so did agriculture growth.
One problem with sustained high government spending is that the government’s fiscal calculations go awry. For fiscal 2020, the country’s fiscal deficit has widened to 4.6 per cent of the GDP, overshooting the government’s revised target of 3.8 per cent. Also, the fiscal deficit in April was already 35 per cent of the target for fiscal 2021 of Rs 7.96 lakh crore due to lower government revenue. Revenues were hit hard after the economy went into a coma due to the lockdown. The government’s net tax revenue came in at Rs 21,412 crore in April, a 70 per cent decline compared to April last year.
Issues like these foretell a rough ride for the economy in the days ahead.
MOODY’S DOWNGRADE REDUCES INDIA TO THE LOWEST INVESTMENT GRADE AND ALIGNS ITS INDIA OUTLOOK WITH AGENCIES LIKE S&P AND FITCH