Why Moody’s ratings downgrade may not matter, for now

A SrinivasKeerthi Sanagasetti | | Updated on: Jun 02, 2020
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Experts think that the negatives are already factored in

There have been concerns raised about global rating agencies downgrading India’s ratings if the fiscal deficit widens too much as a consequence of a large fiscal package or deteriorating growth. Moody’s investors service has been the first to act on this count. But most experts think that there is unlikely to be any short-term impact of the move.

Moody’s has downgraded India’s sovereign (long-term) debt — both foreign and local currency — ratings to Baa3 from Baa2 earlier. Even the short-term local currency rating for the country has been lowered to P-3 from P-2.

The action, taken in context of the coronavirus pandemic, now brings India to the lowest rating of investment-grade. Other rating agencies, such as the Standard & Poor and Fitch — have already rated India’s sovereign debt as BBB- since 2013.

However, based on the rationale and the recent change in Moody’s outlook in November 2019, it is quite evident that the rating downgrade was on cards for quite some time.

Is only Covid to blame?

Following the severe impact of the pandemic, since the beginning of the year, Moody’s has downgraded the ratings for three other countries — Hong Kong (Aa3 rating) South Africa (Ba1) and Mexico (Baa1) — and changed the outlook for four others — France, Thailand, Israel and Saudi Arabia.

However, the tale is not the same for India’s rating downgrade.

According to the rating rationale, “the pandemic only amplifies the vulnerabilities in India’s credit profile that were present and building prior to the shock, and which motivated the assignment of a negative outlook last year.”

This indicates that the rating agency was already skeptical on India’s low growth and rising fiscal risks, which only aggravated with the pandemic and the lockdown that followed.

According to Suyash Choudary, Head, Fixed Income at IDFC Mutual Fund: “A significantly impaired lending system” was one of the causes for the vulnerability in India’s credit profile. He explains that “this was characterised by high banking NPAs and many non-banks struggling to preserve their existing growth models post the 2018 IL&FS shock.”

Further, the economic fallout and the lower-than-expected collection in taxes, predominantly the GST, intensified the pressure on the already reeling fiscal deficit.

While concerns such as temporary dislocation of factors of production and other setbacks to globalisation and trade continue to hamper growth for most economies, their impact on India is somewhat more pronounced, says Choudary.

On the growth front, prior to the pandemic, itself, the real GDP growth slowed to 4.2 per cent in FY20 from 8.3 per cent levels in FY17. Post the pandemic, Moody’s expects the GDP to decline by 4 per cent in FY21.

What the downgrade implies

After the downgrade on June 1, Moody’s joins its peers — S&P and Fitch — in rating India the lowest among investment grade. Generally, such a downgrade could impose risks to India’s debt raising capacity, with a likely aversion from plausible investors. This could also impact the flow of foreign funds into the country’s debt market.

However, in the current context, since the other agencies had already rated India similarly, both the bond and rupee market will hardly be impacted in the near term.

Arvind Chari, Head, Fixed Income & Alternatives at Quantum Advisors, believes that the markets have already priced in this rating downgrade, since its likelihood was visible even earlier.

However, he says, “investors would gauge the growth numbers for the next 4-6 quarters. If the GDP growth does not revive to the levels of 6.5 per cent or above, investors will then start slowly pricing in this risk.”

Also, the timing of the downgrade could be a bit painful, given that India has been trying to make its entry into the global bond indices. Any impairment to this entry, following the rating downgrade, could possibly hamper investor sentiment further.

That apart, since the rating agency has maintained its outlook as ‘negative’ for India, there is now a risk of a further downgrade to sub-investment grade (commonly known as ‘junk’ category).

Can India’s rating fall below the investment grade?

While many risks continue on both the growth and fiscal front, Bank of America Securities (BoFAS), in its recent report suggests that rating falling below investment grade is unlikely due to three buffers. BoFAS believes that on one hand, high forex reserves of the RBI will protect the rupee from any speculative attack, and on the other, an expected good harvest in kharif season this year would help cushion the Covid-19 shock. That apart, the brokerage also expects the Ministry of Finance to de-stress the financial sector, using measures that do not affect the fiscal much. The recapitalisation of public sector banks using the revaluation reserves of RBI was one such measure in the recent past, which the Centre is likely to re-visit given the current scenario.

Published on June 02, 2020

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