In November 2017, Moody’s Investors Service had upgraded India’s rating to Baa2 on expectations that the then progress on reforms would, over time, enhance India’s growth potential. It had believed that the “implementation of key reforms would strengthen the sovereign’s credit profile through a gradual but persistent improvement in economic, institutional and fiscal strength”. However, as the country’s economic data indicates, these expectations have since been belied, as the implementation of the reforms has been “relatively weak”. Acknowledging this, on Monday, the rating agency downgraded India’s foreign-currency and local-currency long-term issuer ratings to Baa3 from Baa2. While the markets may well have factored in this move — Moody’s rating is now in line with that of both Standard & Poor’s and Fitch — the downgrade, nonetheless, underlines the grim economic reality.
The rating agency cited multiple reasons to justify its action: Challenges in the implementation of policies to help offset the risks of low growth, deterioration in the general government fiscal position, and stress in the financial sector. It also emphasised that the decision to downgrade India was not driven by the impact of the COVID pandemic. Rather, the pandemic, and the national lockdown to contain its spread, have exacerbated the economy’s vulnerabilities, which had been building up prior to the virus shock. This view is in line with what the recent economic data indicates. Economic activity in India has been on a steady decline over the past few years — slowing down from 7.1 per cent in the first quarter of 2018-19 to 3.1 per cent in the fourth quarter of 2019-20. These headline numbers mask the underlying weakness as growth is currently being driven only by agriculture and government spending. The situation is likely to have worsened in the first quarter of the current financial year when the full effects of the national lockdown played out.
As is evident, the lockdown is also going to take a toll on government finances. Moody’s expects the general government (Centre and states) debt to rise from 72 per cent of GDP in 2019 to around 84 per cent in 2020. What is especially worrying is that the rating agency believes that the economy will struggle to recover, and that depressed nominal growth will in turn affect the government’s ability to lower its debt burden — it notes that India’s debt burden could rise well beyond 85 per cent of GDP. This is a worrying prognosis. The decision to retain the negative outlook does leave the door open for further rating action down the line. It is also conceivable that other rating agencies will follow suit.