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What does Moody’s rating downgrade reveal about the economy? Hint: COVID-19 is not the villain

Speculations were rife about an impending rating downgrade with India’s economy taking a severe hit due to the COVID-19 outbreak, the government’s fiscal calculations going wrong due to major revenue loss and weakening economic conditions. So, what’s worrying Moody’s with respect to the Indian economy?

June 02, 2020 / 12:45 PM IST

A closer look at Moody’s rating statement, wherein the agency has downgraded the sovereign rating of the country to ‘Baa3’ from ‘Baa2’, provides critical insights. Speculations were rife about an impending rating downgrade with India’s economy taking severe hit due to the novel coronavirus, or COVID-19, outbreak, the government’s fiscal calculations going wrong due to major revenue loss and weakening economic conditions. So, what is worrying Moody’s with respect to India’s economy?

Take a look at the following comments and what does these mean

What 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 this mean: India’s growth was already slowing before COVID-19 impacted the economy. GDP growth fell from over 7 percent to sub-5 percent over a few years on account of lacklustre activity in key growth sectors, including manufacturing and absence of private sector investment participation. Going by the latest GDP data, the Gross Fixed Capital Formation (GFCF), which indicates the investment activity, contracted by 2.8 percent in FY20 as against a growth of 9.8 percent in FY19.

Growth in the manufacturing sector and construction, two key segments from an employment perspective, were at zero and 1.3 percent in FY20 compared with a growth of 5.7 percent and 6.1 percent, respectively, in the previous year. In short, even before the COVID-19 impacted the economy, the economic slowdown had deepened. This is what has possibly triggered the rating action.


Also read: Moody’s downgrade to negatively impact D-Street sentiment, may cap upside near 10,100: Experts

What Moody’s said: 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, all of which the country's policymaking institutions will be challenged to mitigate and contain.

What does this mean: An already slowing economy, which is further impacted by the economic impact of the pandemic, is sure to see stress rising in the financial system. Already, the Indian banking system has gross non-performing assets (NPAs) of over Rs 9 lakh. With the economy going into further stress in the backdrop of the pandemic, business activity is likely to suffer further impacting the ability of companies to pay lenders back. Immediate stress in the financial system is unlikely because of the RBI measures such as loan moratorium to companies till August 31 and liquidity push by RBI and government to ease the cash constraints of companies. But, if the economy doesn’t recover soon, banks may see rise in the stress levels post the moratorium period. India Ratings, the Indian unit of Fitch, estimates the fresh NPAs in the financial system to the tune of Rs 5.5 lakh crore.

What Moody’s said: “While today's (June 1) action is taken in the context of the coronavirus pandemic, it was not driven by the impact of the outbreak. Rather, 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 does this mean: The rating downgrade is not the outcome of the pandemic itself, but reflects the worsening economic profile of the economy that were present even before the pandemic. Does this mean that more rating actions will follow once the impact of pandemic plays out on the Indian economy? Possibly yes.

What Moody’s said: “Slow reform momentum and constrained policy effectiveness have contributed to a prolonged period of slow growth, compared to India's potential, that started before the pandemic and that Moody's expects will continue well beyond it."

What does this mean: Reading between the lines, these remarks are significant criticism on the government’s reform approach so far. Moody’s has taken note of India’s slow reform progress and consistent decline in growth even before the COVID-19 attacked the economy.

What Moody’s said: "Persistent stress among banks and non-bank financial institutions (NBFIs) weighs on growth dynamics through constrained supply of credit for consumption and investment. Moody's does not expect the credit crunch in India's undercapitalised financial sector to be resolved quickly. In turn, subdued growth further challenges the banking system's incomplete resolution of legacy NPAs and governance reforms, and is likely to further weaken asset quality and the health of banks and non-banking financial institutions (NBFIs)."

What does this mean: This comment is critical since NBFC sector is already reeling under tight liquidity crisis. As part of the economic package, both the RBI and the government have announced a slew of measures to infuse liquidity in the NBFC sector. But Moody’s doesn’t expect these measures to resolve the problems in the sector and sees further stress in asset quality.
Dinesh Unnikrishnan
first published: Jun 1, 2020 10:32 pm
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