India’s Credit Rating Downgraded by Moody’s & economic impacts

Early this month, the global credit rating company Moody’s Investor Services downgraded India’s credit rating from Baa2 to Baa3. A few days later, Fitch changed its outlook for India to the “negative” category. In this post, we objective assess what this translates into, for foreign investors, companies in India seeking foreign investment. We also cast light on the government’s perspective as well as the larger economic ramifications of the rating downgrade. 

What is the Baa3 rating of Moody’s?

Moody’s publishes its rankings spread over ten categories – with Aaa reflecting the highest grade. This, therefore, denotes the safest investments. The rankings end with Baa3, reflecting the highest risk of investments. However, the B category reflects moderate risk, and is just a notch above the “junk category”. 

India’s last ranking upgrade in 2017

India received a ranking upgrade in the year 2017 when Moody’s gave a stable outlook to India and upgraded it to rank at Baa2. It is important to remember that 2017 was a year of consistently high inflows of foreign capital. This was set against the background of relaxed FDI norms, rising e-commerce in India, and heavy borrowings of Indian companies from overseas markets. 

Why was India’s rating downgraded?

Based on Moody’s and Fitch reports released after the ranking downgrade, here are the basic reasons for downgrading the Indian economy’s rating – 

1. 1. Problems in implementation of reforms announced in 2017 – The economic reforms such as GST, announcement of labour reforms and fiscal measures are yet to take shape in their intended form. With massive shortfalls in GST and inadequacies in the credit system, the outlook for India remains bleak.

1. 1. A persistently low economic growth over a sustained period – Even before the onset of the pandemic, several indexes were registering a weakening consumption and manufacturing. Electricity consumption, which is a metric of economic growth, has been reducing since 2019. The Index of Industrial Production, which represents output of core industries like mining, minerals.

1. 1. Worsening fiscal figures – At both the central and the state levels, governments have been resorting to increasing borrowing. In the immediate period, has been primarily to meet healthcare needs and rehabilitation of vulnerable populations. However, the ratings downgrade does not consider the impact of a pandemic, but generally refers to the increasing debt burden of states. This has been worsened due to delayed payment of GST share of states, falling consumption, and therefore, a fall in state revenue through taxes, property registration, etc.

1. 1. Mounting stress in India’s financial sector – In the last two years, the Indian financial sector has suffered some major setbacks. The YES Bank crisis, the failure of Punjab and Maharashtra Cooperative Bank, the IL & FS crash, the rising problem of non-performing assets, etc. Off late, a renowned mutual fund like Franklin Templeton has exited the Indian market, adding to the list of troubles for investors in the Indian market.

1. 1. Other conditions – Falling bank credit growth, falling private investments, rising unemployment, and a slowing GDP growth rate.

Impact of the India’s rating downgrade on Investors & Investments  

• A rise in government debt stress means greater uncertainty for global investors. Fitch, in its report, states that it expects the Indian government’s borrowing to increase from 71% currently to 84% of the GDP in the year 2020-21.  This is way more than the limit of 60% debt, recommended by the NK Singh Committee on fiscal responsibility.
• Moody’s latest rating downgrade was over 22 years ago when India tested its nuclear capability in 1998. Since then, up until 2017, the global investment inflow in India has steadily risen almost every year. This pattern shows that ratings may not have a long-lasting effect, provided other economic conditions are positive.
• As India seeks to succeed in its goal of replacing China as the world’s manufacturing hub, a rating downgrade is demotivating for the government. It makes access to loans from international agencies harder. The government also loses its bargaining power to negotiate for lower interest rates.
• The consequent effect on sovereign rating affects global instrument prices such as overseas bonds.
• Rupee’s value weakens and companies seeking loans and capital from outside of India need to pay the higher value.

Prospects for Future – Significance of a rating downgrade for a developing economy with global aspirations 

• With a host of loan, aid, and assistance based reforms in the last three months, the government has been trying to boost both demand and supply. Providing easier access to cheap loans, privatisation of key government businesses could boost investor sentiment.
• The focus on improving the efficiency of ports, roads, and infrastructure would also positively impact India’s business rankings and hence, favourably move investments in the country.
• The Asian Development Bank predicts that the Indian economy will contract by 4% this year. However, with positive fiscal and economic measures, India stands to make leaps in manufacturing. The true test of policy measures would only be a growth in GDP numbers, that have been predicted to fall drastically in the year 2020-21.