Daily Analysis

An in-depth analysis of the best and most relevant editorials of the day from the best dailies known for civil services preparation.

EDITORIAL ANALYSIS

Why Moody’s downgraded India’s rating, what the implications may be?

The Editorial covers GS paper 3[Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.]

Moody's downgrades India's rating; sees FY21 GDP contracting 4 ...

Context

  • Moody’s Investors Service (Moody’s) downgraded the Government of India’s foreign-currency and local-currency long-term issuer ratings to “Baa3” from “Baa2”. 

  • It stated that the outlook remained “negative”.

What is the background?

The latest downgrade reduces India to the lowest investment grade of ratings and brings Moody’s — which is historically the most optimistic about India — ratings for the country in line with the other two main rating agencies in the world — Standard & Poor’s (S&P) and Fitch (see attached chart on the brief history of India’s sovereign rating).

What is the reason for this downgrade?

  • There are four main reasons why Moody’s has taken the decision.

  • Weak implementation of economic reforms since 2017

  • Relatively low economic growth over a sustained period

  • A significant deterioration in the fiscal position of governments (central and state)

  • And the rising stress in India’s financial sector

  • In November last year, Moody’s changed the outlook on India’s Baa2 rating to “negative” from “stable” precisely because these risks were increasing.

  • Since many of the apprehensions that it had in November 2019 have come through, Moody’s has downgraded the rating to “Baa3” from “Baa2”, while maintaining the negative outlook.

  • In its official statement, Moody’s said, “The decision to downgrade India’s ratings reflects Moody’s view that the country’s policymaking institutions will be challenged in enacting and implementing policies which effectively mitigate the risks of a sustained period of relatively low growth, significant further deterioration in the general government fiscal position and stress in the financial sector”.

What does “negative’ outlook mean?

  • “The negative outlook reflects dominant, mutually-reinforcing, downside risks from deeper stresses in the economy and financial system that could lead to a more severe and prolonged erosion in fiscal strength than Moody’s currently projects”.

  • In particular, Moody’s has highlighted persistent structural challenges to fast economic growth such as “weak infrastructure, rigidities in labor, land and product markets, and rising financial sector risks”.

  • In other words, a “negative” implies India could be rated down further.

Is the downgrade because of Covid-19 impact?

  • No. Moody’s was categorical that while this downgrade is taking place “in the context of the Coronavirus pandemic, it was not driven by the impact of the pandemic”.

  • According to Moody’s “the pandemic amplifies 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”.

What will be the implications of this downgrade?

  • As explained above, ratings are based on the overall health of the economy and the state of government finances. 

  • A rating downgrade means that bonds issued by the Indian governments are now “riskier” than before, because weaker economic growth and worsening fiscal health undermine a government’s ability to pay back.

  • Lower risk is better because it allows governments and companies of that country to raise debts at a lower rate of interest.

  • When India’s sovereign rating is downgraded, it becomes costlier for the Indian government as well as all Indian companies to raise funds because now the world sees such debt as a riskier proposition.

 

Conclusion

Moody’s expects India’s real GDP to contract by 4.0% in the current financial year. Thereafter it expects a sharp recovery in 2021-22. But over the longer term, it states “growth rates are likely to be materially lower than in the past, due to persistent weak private sector investment, tepid job creation and an impaired financial system”. It states that “a prolonged period of slower growth may dampen the pace of improvements in living standards…”

 

Source: Indian Express.



 
-->