Moody's outlook downgrade for India: Backward-looking course correction

After two years of upgrading its rating to Baa2 (stable outlook) on November 16, 2017, Moody’s has now downgraded India’s sovereign rating to 'negative' from 'stable'.

We believe Moody’s lack of conviction on its earlier rating has come in too soon. In its earlier rating, the agency cited that structural reforms would feed into strong growth outlook, which would improve India’s debt repayment and servicing capability.  Moody’s anticipated that reforms by the incumbent government would usher in the improved business climate, enhance productivity, stimulate investments, and ultimately foster strong and sustainable growth.

In contrast, Moody’s now sees increasing risks to India’s economic growth, which it believes will remain materially lower. It also sees lower effectiveness of  the government and its policy measures.

Clearly, we believe Moody’s recent downgrade highlights that the agency’s robust expectations in 2017 were misplaced. Here are our reasons why:

1) India’s rating between 1990 and 2017 ranged mostly from Ba1 to Baa3, ie, below investment grade, at a time when at least until 2012, the country experienced substantial gains in productivity, savings, investments, employment, corporate profitability, the rise of private banks, gains in tax buoyancy, etc.

Ironically, Moody’s rating upgrade in November 2017 to its highest rating in 27 years came at a time when India was experiencing a structural decline in all these positive enablers.

2) India has been in a constant phase of reforms, including formalisation - demonetisation and GST implementation in 2016-17 were not the only occasions of major or perceived reforms. However, until now, the extent of damage done by these two measures alone has significantly dampened the economy. 

3) Given the structural decline in India’s potential growth since 2011-12, especially in the context of rising protectionism, it was evident that India would face debt sustainability issues from multiple quarters. We see a manifestation of these in the form of a steep rise in farm sector loan waivers, dented viability of the manufacturing sector, erosion of the informal economy, NPAs in the banking sector and a cumulative Rs 2.3 trillion recapitalisation of PSU banks, persistent NBFC problems - all these have only worsened government finances.

Importantly, the continuing decline in private investments since its peak in 2008-2011 (for the longest period since the 1950s) belies Moody’s earlier expectation of sustainable higher growth.

Moody’s recent downgrade of India’s rating outlook to Negative from Baa2 (stable outlook) can be seen as a course correction, in our view.

This course correction seems more of a post facto reaction to a sustained deceleration in growth (real GDP decelerated to a low of 5% in Q1FY20 from 8-9% during 2004-2012), suggesting a backward-looking response than forward-looking guidance.

Ironically again, this comes at a time when the US-China trade conflict is ebbing from its peak and amid growth-stimulating policy measures that seem to be paving the way for better cyclical growth in the coming quarters.

(The author is Head of Strategy & Chief Economist, IDFC Securities. The views expressed in this article are personal.)