Why Moody's downgrade is not a bolt from the blue but still not justified

While this downgrade will not affect the sovereign as it does not borrow overseas, it will however affect Indian companies borrowing from abroad

The lowering of India’s credit ratings by Moody’s from Baa2 to Baa3 with a negative outlook does not come as a shock considering that downgrading of all countries due to the pandemic was quite likely given the way things have turned out. However, it was logical to assume that no such judgment call would be taken at this point of time. Let’s see the basis for the same.

The first point made is about lower GDP growth in the present conditions. This holds for probably all economies and though the IMF spoke of positive growth and the UN called India one of the shining stars for 2020, the RBI has talked about a negative growth rate this year. However, what is important from Moody’s standpoint is that the agency believes that the plethora of policies announced by the government even before the pandemic set in have not worked. This is debatable given the time lags involved in policies working out. Admittedly there have been more of supply side impulses provided by the government rather than the demand side and this has skewed the CRA’s decision as there has not been much of stimulus on the demand side and has been confined to relief. This is something that can be looked at more closely by the government.

The second point is the fiscal situation which is certainly grim. The FY20 numbers have shown a much higher fiscal deficit ratio which will get exacerbated this year with fall in revenue and higher relief expenditure. Here the CRA is concerned on the high debt level which has gone up from 72% in 2019 to 84% of GDP in 2020. This is again expected given the higher borrowing programme announced by the government this year which goes up by Rs 4.2 trillion. The handicap is both higher absolute debt level as well as lower growth in GDP which could be barely positive given the extent of decline in real GDP.

The third concern flagged by Moody’s is that the stress in the financial system would increase and it is a legitimate concern given that the moratorium announced on loans would have to be serviced at some time. This can potentially be a stress point for the financial system at a later date.

Should India be concerned? The sovereign does not borrow overseas and hence this should not make a difference. However, Indian companies borrowing from outside will have challenges when factoring in the cost. There is also a possibility of other ratings agencies like S & P and Fitch following suit which has to be observed.

Is this justified? Probably not as this is the kind of situation to be witnessed for almost all countries where governments have been more aggressive with spending under these pressing times. It would be interesting to see if similar action is taken against other nations too as low growth, higher debt and financial sector stress go along with almost all countries which have had a shutdown where activity has come to a standstill. Ideally one could have waited for another year before taking such a call as the true picture of any economy would emerge only after this black swan event is behind us. From the point of view of the government it would be instructive to examine on merit the concerns of the rating agency and address them if they so need to be tackled.

Madan Sabnavis is chief economist at CARE Ratings. Views are personal.