India’s credit rating at Baa2 is the second lowest investment rating and Moody’s has warned that India could be heading for a debt trap and recessionary phase.
The negative outlook indicates that an upgrade is unlikely in the near term. Moody’s would likely change the rating outlook to stable if the likelihood that fiscal metrics would stabilize and improve over time increased significantly.
Moody’s would likely downgrade India’s ratings if its fiscal metrics were increasingly likely to weaken materially. This would probably happen in the context of a prolonged or deep slowdown in growth, with only limited prospects that the government would be able to restore stronger growth through economic and institutional reforms
Looking forward, Moody’s said potential GDP growth and employment generation will remain constrained unless reforms are advanced to directly reduce restrictions on the productivity of labor and land, stimulate private sector investment, and sustainably strengthen the financial sector.
“Moody’s considers the prospects for effective implementation of such reforms to have diminished since its upgrade of India’s sovereign rating in 2017.
In the absence of such reforms, structural constraints on productivity and job creation, will weigh further on India’s sovereign credit profile,” it added.
Moody’s has attributed the negative outlook on lower economic growth and lack of effective government policy to address macro issues which will in turn lead to a spike in the debt burden of the country.
“Moody’s decision to change the outlook to negative reflects increasing risks that economic growth will remain materially lower than in the past, partly reflecting lower government and policy effectiveness at addressing long-standing economic and institutional weaknesses than Moody’s had previously estimated, leading to a gradual rise in the debt burden from already high levels,” Moody’s said.
Moody’s has painted a grim picture of the economy pointing to rural stress, weak job creation and NBFC liquidity crunch as the reasons for a more prolonged slowdown in the economy.
“While government measures to support the economy should help to reduce the depth and duration of India’s growth slowdown, prolonged financial stress among rural households, weak job creation, and, more recently, a credit crunch among non-bank financial institutions (NBFIs), have increased the probability of a more entrenched slowdown,” Moody’s said.
The rating agency is also very cautious about future reform moves as the scope has diminished and options have been reduced.
“Moreover, the prospects of further reforms that would support business investment and growth at high levels, and significantly broaden the narrow tax base, have diminished,” it said.
It has pointed to the risk of an increasing budget deficit and debt burden. “If nominal GDP growth does not return to high rates, Moody’s expects that the government will face very significant constraints in narrowing the general government budget deficit and preventing a rise in the debt burden,” Moody’s added.
The Finance Ministry responded to Moody’s change in outlook by saying it has noted that the Moody’s Investors Service has today changed the outlook on the Government of India’s ratings to negative from stable while keeping the foreign-currency and local-currency long-term issuer ratings unchanged at Baa2.
The government has undertaken series of financial sector and other reforms to strengthen the economy as a whole. Government of India has also proactively taken policy decisions in response to the global slowdown.
Trying to dispel the effectiveness of reform measures and growth prospects, the Finance Ministry said, “These measures would lead to a positive outlook on India and would attract capital flows and stimulate investments.
The fundamentals of the economy remain quite robust with inflation under check and bond yields low. India continues to offer strong prospects of growth in near and medium term”.
The Finance Ministry pointed out that India continues to be among the fastest growing major economies in the world, India’s relative standing remains unaffected.
IMF in their latest World Economic Outlook has stated that Indian Economy is set to grow at 6.1 per cent in 2019, picking up to 7 per cent in 2020.
As India’s potential growth rate remains unchanged, assessment by IMF and other multilateral organizations continue to underline a positive outlook on India, it said.
Giving the rationale for changing the outlook to negative from stable, Moody’s said there is a rising risk from an entrenched growth slowdown as medium term reform prospects have dimmed and stress in the financial sector has increased.
India’s economic growth has slowed materially, with real and nominal GDP growth falling to 5 per cent and 8 per cent year on year in April-June 2019, respectively. Moody’s estimates that the growth slowdown is in part long-lasting.
Moreover, compared with two years ago when Moody’s upgraded India’s rating to Baa2 from Baa3, the probability of sustained real GDP growth at or above 8 per cent has significantly diminished.
Rather, the downside risks to the growth outlook have increased as prospects for economic and institutional reforms that would lift and maintain growth at high rates have diminished, it said.
In the context of a prolonged period of weak investment, private consumption has slowed, driven by financial stress among rural households and weak job creation.
“Moody’s does not expect the credit crunch among NBFIs, major providers of retail loans in recent years, to be resolved quickly,” it said.
With public sector banks still dealing with the legacy of nonperforming loans accumulated at the beginning of the decade, credit supply is likely to remain impaired for some time, compounding the income shocks.
“With a per-capita income of around $7,900 on a purchasing power parity (PPP) basis in 2018, Indian households’ capacity to absorb such negative shocks is limited,” Moody’s pointed out.
Although Moody’s expects the recent reform measures by the government these measures to provide support to the economy, they are unlikely to restore productivity and real GDP growth to previous rates.
Moreover, the multiple facets of the slowdown and structural weaknesses in the real economy and financial system that it reflects point to further downside risks to Moody’s expectations that real and nominal GDP growth will rise towards 6.6 per cent and 11 per cent respectively over the next year.
In turn, a prolonged period of slower economic growth would dampen income growth and the pace of improvements in living standards, and potentially constrain the policy options to drive sustained high investment growth over the medium-to long term, Moody’s said.