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Moody’s outlook cut EXPLAINED: On demonetisation’s 3rd anniversary, blow to India’s credit rating

Samrat Sharma
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On the third anniversary of demonetisation, Moody's cut in India's rating outlook from stable to negative has come as a blow. While Moody's has held prolonged economic slowdown and increasing debt responsible for its move, the Finance Ministry has responded by highlighting that India continues to be among the fastest-growing major economies in the world and the government has undertaken a series of financial sector and other reforms to strengthen the economy as a whole. Back in 2017, calling demonetisation and GST as reforms, Moody's Investors Services upgraded India's sovereign ratings from the lowest investment grade to a notch higher. 

What are different general credit ratings

  • AAA: Highest credit quality that denotes the lowest expectations of default risk.
  • AA+/AA/AA-: Very high credit quality. 'AA' ratings denote expectations of very low default risk. They indicate very strong capacity for payment of financial commitments. 
  • A+/A/A-: High credit quality that denotes expectations of low default risk. The capacity for payment of financial commitments is considered strong, however, vulnerability to adverse business or economic conditions exists. 
  • BBB+/BBB/BBB-: Good credit quality that indicates that expectations of default risk are currently low. The capacity for payment of financial commitments is considered adequate, but adverse business or economic conditions are more likely to impair this capacity. 
  • BB+/BB/BB-: This rating indicates an elevated vulnerability to default risk, particularly in the event of adverse changes in business or economic conditions over time; however, business or financial flexibility exists that supports the servicing of financial commitments. 
  • B+/B/B-: This rating indicates that material default risk is present, but a limited margin of safety remains. Financial commitments are currently being met; however, capacity for continued payment is vulnerable to deterioration in the business and economic environment. 
  • CCC+/CCC/CCC-: Substantial credit risk exists in this rating, where the default is a real possibility.
  •  CC: This rating shows a very high level of credit risk with a possibility of defaults.
  •  C: This rating shows that a default or default-like process has begun, or the issuer is in a standstill. 
  • DDD/RD/SD/DD/D: This indicates that the issuer has entered into bankruptcy filings, administration, receivership, liquidation or other formal winding-up procedure or has ceased business. 

While S&P and Fitch use above ratings, Moody’s uses a slightly different set of ratings. Moody’s uses numbers instead of ‘+’ or ‘-‘. For instance, AA+ and AA- are written as Aa1 and Aa3, and BBB+ and BBB- are written as Baa1 and Baa3.

Where does India stand in ratings

Apart from Moody's, other credit agencies Fitch Ratings and S&P have kept India's rating at 'BBB-' with a stable outlook. Fitch had last upgraded India’s sovereign rating from BB+ to BBB- on 1 August 2006.

How does ratings outlook impact

Ratings outlook assesses the potential direction of a long-term credit rating over the intermediate-term (typically six months to two years). In determining a rating outlook, consideration is given to any changes in economic or fundamental business conditions. However,  the outlook is not necessarily a precursor of a rating change or future action.

A positive outlook means that a rating may be raised, while a negative outlook means that a rating may be lowered. Stable means that a rating is not likely to change. A poor credit rating suggests that the borrower has trouble paying back loans in the past and might follow the same pattern in the future. The credit rating affects the entity’s chances of being approved for a given loan or receiving favorable terms for said loan.

In fact, the lower the credit rating, the riskier it is considered and the higher the interest rates are charged. Some institutional investors are not even allowed to hold debt with a credit rating of BB or below. Hence, a downgrade in ratings can make foreign borrowings expensive for India and can restrict a few portfolio investors from investing in India.