Moody's rating action unjustified; experts for aggressive rate cut by RBI

Given the economic slump, most economists have lowered their FY20 growth estimates and expect the RBI to be more aggressive in cutting rates going ahead

Moody’s investors service tucked a grey feather in India’s hat, as it changed its sovereign rating outlook to “negative” from “stable”, retaining the rating itself at the existing Baa2. 

A southward change in outlook, without deterioration in the rating, is akin to a “warning sign” about the future rating, economists said. 

Moody’s underlined that a “more entrenched slowdown” after economic growth dropping to a six-year low cannot be ruled out. This “prolonged period of slower economic growth” could limit the efficacy of policy options, and hence the change in outlook, the agency said. 

The negative outlook, the rating agency said, reflects rising risks that growth will remain significantly lower than in the past, partly reflecting lower policy effectiveness.  It has forecast a fiscal slippage to 3.7 per cent of the gross domestic product (GDP) for FY20, higher than the government’s target of 3.3 per cent. 

Sonal Varma, chief Asia economist at Nomura, said that change in the outlook is a “negative surprise”, but said Nomura was in agreement with Moody’s assessment of the economy. 

“In an environment of weak global demand, these are substantial growth headwinds, which will likely delay the growth recovery and lead to below-trend growth for a longer period than we had previously envisaged,” Nomura said in a note. 

It pointed out that Moody’s was the only agency to upgrade the rating two years ago, giving a higher rating in comparison to its peers, in November 2017. 

Former chief statistician of India Pronab Sen said that this is a warning sign for the economy, and the commentary is more serious than just slowing growth. 

“It casts aspersions on the viability of the economic system. It means that they are actively considering lowering India’s rating,” he told Business Standard.  Sovereign ratings find their biggest relevance for countries that borrow foreign money either in onshore or offshore financial markets to service their national debt, and they have a direct impact on the interest rates on those debt instruments. 

In simple terms, a ratings downgrade typically makes sovereign bonds cheaper, and the interest rate (or their yield) rises. A negative outlook typically points to a higher probability of a ratings downgrade in future. 

India does not borrow in the form of foreign currency denominated bonds yet, and only about 3 per cent of its debt is financed by foreign players onshore. Experts said while a downgrade would shake things up, change in outlook would not move things.

Sen added that this change in outlook by Moody’s could make the Centre reconsider the prospects, if any, of the government of India borrowing money in the form of foreign-currency denominated sovereign bonds. 

N R Bhanumurthy, an economics professor at the National Institute of Public Finance and Policy (NIPFP), said India’s medium to long term prospects are on a strong footing, but the immediate fiscal concerns are more worrying. 

“The main concern is that the quality of expenditure is deteriorating; consumption-oriented spending is being focused at the cost of long-term capital investment,” he said. 

He added that Moody’s assessment primarily seems to be done based on short-term indicators. Most high frequency indicators point to a bleak situation, he said. 

In consonance with Moody’s assessment, Nomura revised India’s GDP growth estimate downward, and pegged it at 4.9 per cent for FY20. Along with the Japanese holding company, several others said that the extension of the rate cut cycle is the only way forward.  “Lending rate cuts are the only way out of the ongoing slowdown. The bad news is that still high real lending rates and relatively muted Diwali demand have led us to formalise a 30 bps cut to our FY20 gross value added (GVA) growth forecast to 5.8 per cent,” wrote Indranil Sen Gupta, director and India economist at BofAML. 

“The MPC (monetary policy committee) appears to be trying to signal to the bond market that rate cuts may keep coming, particularly as it has sharply cut growth forecasts. Lower rates are a condition for the economy to pick up, even if no longer sufficient,” said Neelkanth Mishra, co-head of equity strategy, Asia Pacific & India equity strategist at Credit Suisse, in a recent note.