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Explained: Moody’s cuts India outlook to negative. What does it mean?

Sunny Verma
Moody's also affirmed India's Baa2 local-currency senior unsecured rating and its P-2 other short-term local-currency rating.

Global ratings agency Moody's Investors Service Friday cut its outlook on the Government of India's ratings to negative from stable, but affirmed the Baa2 foreign-currency and local-currency long-term issuer ratings.

Moody's also affirmed India's Baa2 local-currency senior unsecured rating and its P-2 other short-term local-currency rating.

Moody's said its decision to change the outlook to negative reflects increasing risks that economic growth will remain materially lower than in the past, partly reflecting lower government and policy effectiveness at addressing long-standing economic and institutional weaknesses than Moody's had previously estimated, leading to a gradual rise in the debt burden from already high levels.

Moody’s comments come days after S&P Global Ratings warned that risks of contagion are rising in the Indian financial sector.

What is the impact?

Reduction in outlook is the first step towards an investment downgrade, as India is now just a notch above the investment grade country rating. An actual downgrade in country ratings can lead to massive foreign fund outflows.

However, if the government is able to address fiscal deficit concerns through higher fund raising from stake sales, the rating agencies tend to revise up their outlook.

Why has Moody’s cut rating?

While government measures to support the economy should help to reduce the depth and duration of India's growth slowdown, prolonged financial stress among rural households, weak job creation, and, more recently, a credit crunch among non-bank financial institutions (NBFIs), have increased the probability of a more entrenched slowdown, it said.

Moody’s said the prospects of further reforms that would support business investment and growth at high levels, and significantly broaden the narrow tax base, have diminished.

If nominal GDP growth does not return to high rates, Moody's expects that the government will face very significant constraints in narrowing the general government budget deficit and preventing a rise in the debt burden.

What does the government say?

Noting Moody’s concerns, the Finance Ministry said that India continues to be among the fastest growing major economies in the world, and India’s relative standing remains unaffected.

The Government said it has undertaken series of financial sector and other reforms to strengthen the economy as a whole. It has also proactively taken policy decisions in response to the global slowdown.

These measures would lead to a positive outlook on India and would attract capital flows and stimulate investments, the Government said. The fundamentals of the economy remain quite robust with inflation under check and bond yields low. India continues to offer strong prospects of growth in near and medium term, it said.

Markets in India opened 100 points down on Friday. The rupee was down 22 paise against the dollar.