Moody's warns of rating downgrade if growth declines

Also warns on fiscal deficit, forex reserves, asset quality of PSU banks

Retaining a stable outlook on India's lowest investment rating, Moody’s Investors Service has warned the economy could be downgraded if the government adopts policies that harm its fiscal and growth prospects. The ratings could also be lowered if forex reserves decline significantly, public sector banks’ asset quality deteriorates and high inflation persists, it added.

In two separate reports, the rating agency expressed apprehension that reforms could be delayed due to elections and specifically assigned a negative outlook on refinery,  steel, metals, mining and automotive companies. However, it had a stable outlook on the telecom sector.

“Downward pressure on the rating could develop if policies that impair the growth and fiscal outlook are implemented or there is a material decline in foreign exchange reserves’ coverage of external debt and imports,” Moody’s said in its latest credit analysis.

It added the ratings could be downgraded if “state-owned banks’ asset quality deteriorates so that bank recapitalisation costs rise well above the current estimates or high inflation persists, damaging the fiscal, growth and balance of payments outlook”.

The Centre's fiscal deficit is pegged to be contained at 4.8 per cent of the gross domestic product (GDP) in the Budget for 2013-14, but it has already touched 84 per cent of the Budget estimate (BE) in the first seven months. The retail price inflation entered the double digits in October after a gap of six months, while the wholesale price index-based rate of price rise increased to seven per cent from 6.46 per cent in October.

India's forex reserves rose by $2.69 billion to $286.26 billion for the week ended November 22, helped by a sharp increase in foreign currency assets, Reserve Bank of India (RBI) data showed.

The finance ministry has proposed to provide Rs 14,000 crore for capital infusion in the current financial year. It provided Rs 12,517 crore of additional capital into 13 public sector banks in 2012-13.

On the other hand, Moody's could upgrade rating as well if fiscal metrics and competitiveness indicators improved, it said.

For now, the rating outlook is stable. "The rating outlook is stable, reflecting our view that the currency, maturity and real interest rate structure of government debt supports the sovereign credit profile during the period of slower growth, high inflation, currency volatility and political uncertainty, and that the level of foreign exchange reserves is an adequate buffer against balance of payments pressures," Moody's said.

It said India’s GDP growth remains above the median for similarly rated countries, although it has slowed from an annual average of 8.5 per cent between 2003 and 2010 to 4.8 per cent in the third quarter of 2013 (calendar year).

Moody's expected a slow recovery in growth in the second half of 2014, which is quite far from the government optimism that the recovery would come from the second half of 2013-14 (third quarter of 2013 calendar year).

"We expect a slow recovery in the second half of 2014, if global growth increases while domestic inflation and interest rates decline. In addition, national elections in 2014 could affect growth, depending upon their impact on sentiment and policies."

In another report on non-financial companies, it pegged economic growth at 5.5 per cent only in 2014-15.

Moody's assigned a negative outlook on India's non-financial sector due to macro economic challenges in the next 12 months including a possible delay in reforms due to elections.

The rating agency has a negative outlook on India's oil refining and marketing sector, steel, mining and metal companies as well as automotive companies. However, it assigned a ‘stable’ outlook to the telecom sector.

Moody's said while the rupee's 15 per cent depreciation against the dollar since March 2013 has fostered inflation and raised the government’s fuel subsidy costs, it has a limited impact on sovereign debt servicing costs, because only 5.4 per cent of government debt is owed in foreign currency.

All the three major rating agencies - Moody's, Standard & Poor's and Fitch - have assigned India the lowest investment grade. S&P also has a negative outlook on these ratings, whereas Fitch and Moody's have a stable outlook. Any downgrade of India's rating to junk would lower investors’ confidence in India's economy and could make accessing foreign funds costlier.