India’s Sovereign Rating Cut at Moody’s Citing Policy Risks

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India's credit rating was cut to the lowest investment grade by Moody's Investors Service, citing policy challenges in addressing a prolonged slowdown and the government's deteriorating fiscal position.

The nation's long-term foreign-currency credit rating was cut to Baa3 from Baa2, according to a statement. The outlook remains negative.

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

India missed its fiscal deficit target for the year ended March even before the worst of the coronavirus hit the economy, with economists seeing the budget sliding deeper into the red this year. That's leading to calls for the central bank to directly monetize the deficit.

Read: ‘Dire' Revenue Need Behind $159 Billion India Bond Sale Plan

“The government will be more cautious about direct monetization in primary market,” said Abhishek Goenka, chief executive at India Forex Advisors Pvt. “The government's aim at debt indices inclusion may also suffer a setback.”

The cut brings Moody's rating on India on par with S&P Global Ratings and Fitch Ratings Ltd., both of which have a BBB- rating. The rupee fell in offshore trading on the move. The one-month dollar/rupee contract rose to 76.01 before paring gains. It was last up 0.1% to 75.84.

Little Changed

SGX Nifty 50 Index futures in Singapore were little changed at
8:26 p.m. Mumbai time after the underlying gauge capped its
fourth day of gains -- the longest winning streak in a month.
Indian equities have risen in recent days after the government
took steps to start easing a lockdown to contain Covid-19 and foreigners turned net buyers of local shares in May.

The downgrade comes at a time when economic growth in India slowed to 3.1% in the first three months of this year, and the coronavirus pandemic pushes the economy toward its first full-year contraction in four decades.

“India faces a prolonged period of slower growth relative to the country's potential, rising debt, further weakening of debt affordability and persistent stress in parts of the financial system,” the ratings company said. These are challenges “the country's policymaking institutions will be challenged to mitigate and contain.”

With India opening up its high-yielding debt market to foreigners, any downgrade by S&P and Fitch would hurt inflows into a nation that relies on imported capital to fund investment.

Expected Lines

“The FII outflows are likely to continue,” said Chakri Lokapriya, managing director at TCG Asset Management Pvt. The downgrade itself “is on expected lines and is unlikely to impact the market in a meaningful way.”

Following the passage of the goods and services tax and bankruptcy reforms in 2017, Moody's surprised many by then upgrading India's sovereign rating by one notch -- from Baa3 ‘positive' to Baa2 ‘stable'.

But within two years, Moody's downgraded the outlook from ‘stable' to ‘negative' as growth sputtered and a shadow banking crisis played out. Moody's has said it doesn't expect the credit crunch among non-bank financial institutions, which were the main source of consumer loans in recent years, to be resolved quickly.