Moody’s Downgraded India: Breaking Down The Implications

Source: Tavaga Research

Moody’s Investors Service downgraded India’s credit rating to Baa3 from Baa2 on Monday, maintaining a negative outlook and referring to a prolonged period of slow growth, rising debt and persistent strain in parts of the financial system. This change brings Moody’s rating into line with Fitch and Standard and Poor’s, both of which rate India BBB-, although they assign stable rather than negative outlooks.

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What is a credit rating?

A credit rating is an evaluation of the credit risk of a prospective debtor which can be an individual, a business or a government. There are several credit rating agencies that provide research and ratings, the top three credit rating agencies are Standard & Poor’s (S&P), Moody’s and Fitch. These rating agencies provide ratings on the system of assigning a letter to grade the debt. The highest credit quality is denoted by AAA symbol which is followed by AA, A, BBB, BB, B, C and D. Debt rated BBB and above is considered investment grade and below junk grade. For example, when a bond is downgraded, it might move from an “A” rating to a “BBB” rating, a downgrade may be contrasted with an upgrade. 

What is a downgrade?

A downgrade is a negative change in an analyst’s perspective of a specific debtor, the downgrade can be triggered by both qualitative and quantitative information primarily contributing to the decrease in the financial health of the debtor. A Rating downgrade suggests that the economy combined with the financials of the issuer have worsened and the ability to repay on time may not be possible.

Why did Moody’s downgrade India’s rating?

Weak implementation of economic reforms since 2017 combined with a significant deterioration in the fiscal position of the government has caused low economic growth over a sustained period resulting in rising stress in India’s financial sector.

Although the cut was not driven directly by the impact of the coronavirus, the pandemic continues to amplify vulnerabilities in India’s credit profile that were present and building before the shock.

The Government has announced several steps to help the poor and small businesses weather the pandemic, but Moody’s does not expect the measures to push India’s growth rate back towards the 8% that had recently seemed within reach.

Asian Financial Crisis (1997-1998)

Well, this isn’t the first time an Asian economy went into a downward spiral due to increasing debt pressure, On July 2, 1997, Thailand devalued its currency relative to the US dollar. The unfolding crisis in Thailand illustrated how problems in the banking sector could lead to a pullback by foreign investors, setting off a spiral of depreciation, recession and amplified banking sector weakness. The result was contagion, with foreign creditors pulling back from other countries in the region seen as having similar vulnerabilities. In particular, a number of emerging market economies in Latin America and Eastern Europe, including Brazil and Russia, faced significant balance-of-payments pressures in 1998, reflecting spillovers from the Asia crisis as well as homegrown vulnerabilities, some of which were quite different from those at the heart of Asia’s crisis.

What is Moody’s rating for India?

The latest downgrade reduced India to the lowest investment grade of ratings and it also brings Moody’s at par with the other two main rating agencies in the world – Standard & Poor’s (S&P) and Fitch.

• Erosion in fiscal strength: The negative outlook by Moody’s mirrors dominant, mutually-reinforcing, downside risks from deeper stresses in the economy and financial system that could potentially usher to a drastic and continued erosion in fiscal strength than Moody’s other current projects.
• Increase in borrowing risk: A downgrade means 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. To explain it a little, if India’s sovereign rating is downgraded, it becomes costlier for the Indian government and Indian companies to raise funds because debt is now perceived as a riskier option by the world.
• Lower growth rates: Moody’s believes that 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.
• Difficult economic recovery: Significantly higher debt burden in comparison with peers in the same rating category with grossly undercapitalized banking & finance sector due to an expected spike in bad loans will continue to be a struggle on any prospect of rapid economic recovery.

Moody’s has emphasized continuous structural challenges to fast economic growth such as weak infrastructure, rigidities in labour, land and product markets and rising financial sector risks.

However, what remains a concern is the negative outlook on India’s rating maintained by Moody’s which potentially leaves India open to another downgrade, taking it down into junk territory.