Institutional Complications are Credit Negative: Moody's

Moody's Investors Service has said India's policymaking institutions will encounter challenges in enacting and implementing policies which effectively mitigate the risks of a sustained period of relatively low growth.

Other challenges will include significant further deterioration of the general government fiscal position and stress in the financial sector. On June 1, Moody's had downgraded of the government's foreign-currency and local-currency long-term issuer ratings to Baa3 from Baa2.

It said the coronavirus outbreak has amplified existing vulnerabilities in India's credit quality. The country faces a prolonged period of slower growth compared with its potential, rising debt, further weakening of debt affordability, and persistent stress in parts of the financial system.

These factors pose difficulties for the country's policymaking institutions. Slow reform momentum and muted policy effectiveness have contributed to continued slow economic growth. These trends began before the pandemic and will likely continue well beyond it.

Lower real and nominal GDP growth this year will diminish the government's ability to reduce its debt burden, which has risen significantly as a result of the coronavirus.

Additionally, a mixed track record on implementing revenue-raising measures lowers the prospects of fiscal policy-driven budget consolidation, which will amplify long-standing weakness in India's credit quality.

The credit effects will be negative for issuers with strong ties to the government, including government-related issuers as well as companies and banks with associated counterparty linkages.

Nevertheless, several credit strengths will somewhat offset the country's weakening growth and fiscal prospects and support the credit quality of the sovereign. India's large and diverse economy provides key support, and prospects for population growth and catch-up in productivity boost growth potential over the long term.

The country's relatively strong external position contributes to the economy's ability to weather challenges by helping to limit the negative effect of abrupt changes in financing conditions. A large pool of domestic private savings, which is available to finance government debt, mitigates the fiscal risks from high government debt and weak debt affordability.

"Slow reform momentum and constraints on policy effectiveness have contributed to a prolonged period of slow growth compared to India's potential. These trends started before the pandemic and will likely continue well beyond it," said Moody's in a sector in-depth report.

Coronavirus-related business disruptions will worsen the country's economic slowdown and accelerate deterioration of financial institutions' asset quality and profitability, it added. At the same time, the increased liquidity stress of non-banking financial institutions will pose a risk to the stability of the broader financial system, given banks' large direct exposures to these entities.

"The economic shock will strain the already weak solvency of public sector banks and, in the absence of external capital support from the government, we expect their capitalisation to deteriorate. This will result in weakening of their standalone credit profiles. Despite the near-term pressure on their asset quality, profitability and capital, we expect their funding and liquidity to remain key credit strengths."

Private sector banks are also under strains, although they have stronger loss-absorbing capacity than do public sector banks. The asset quality of private sector banks will also deteriorate as loan impairments increase, pushing up credit costs.

Still, their credit profiles will remain stronger than those of government banks, thanks to higher levels of capitalisation and loan-loss reserves, said Moody's.