While little cogent evidence emerges of the economy starting to look up or the malaise in the shadow banking sector being decidedly contained, Moody's Investors Service late on Thursday cut India's sovereign credit rating outlook to 'negative' from 'stable' - the first step towards a downgrade. It cited "increasing risks that the country's economic growth will remain materially lower than in the past" and the resultant gradual rise in an already-high debt burden. It affirmed the Baa2 foreign-currency and local-currency long-term issuer ratings for India, the second lowest investment grade score.
The rating agency said its decision to revise the outlook was partly attributable to "lower government and policy effectiveness at addressing long-standing economic and institutional weaknesses", causing the government here to confute this view and assert that "India continues to offer strong prospects of growth in the near and medium-term".
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However, independent agencies appeared not buying into the government's argument - Nomura, for instance, slashed its 2019 GDP growth projection for India to 4.9% from 5.7% forecast earlier; it also cut the forecast for 2020 steeply from 6.9% to 6%. "We now believe GDP growth did not bottom in Q2 and will likely slide further to 4.2% in Q3," Sonal Varma, managing director and chief India economist, wrote.
Moody's had in November 2017 raised its rating for the government of India a notch from Baa3 (lowest investment grade) to Baa2 after a long gap of 14 years but peers Standard & Poor's and Fitch persisted with their the lowest investment grade ratings for the country.
The lowering of outlook will put extra pressure on the Narendra Modi government, which is facing flak for the severe economic slowdown. Finance minister Nirmala Sitharaman has announced a series of steps over the last few weeks to reverse the slowdown, most aimed at catalysing investments and many effectively undoing some of the announcements in her maiden Budget.
There is still a crescendo of demands for further reforms to address the structural problems that prevent the economy from returning fast to the high-growth trajectory. Moody's wrote: ".. the downside risks to the growth outlook have increased as prospects of economic and institutional reforms that would lift and maintain growth at high rates have diminished. Stress among (NBFCs), with the possibility of more severe credit crunch that would affect credit supply, both directly and through linkages with non-banks and banks, adds to the downside risks to the medium-term growth outlook". The drivers of (India's) economic deceleration were multiple and mainly domestic, it added.
The credit crunch among NBFCs might not be resolved quickly, the agency observed, adding that with public sector banks still dealing with legacy of NPAs, credit supply in the economy would likely remain impaired for some time, compounding the income shocks.
Moody's believes that if nominal GDP growth does not return to high rates, the government will face very significant constraints in narrowing the general government budget deficit and preventing a rise in the debt burden. With the weak economic growth, the central government has had to revise the glide path of fiscal consolidation in recent years. Also, the Centre's actual fiscal deficit, including off-budget spending, is seen to be higher than reported. This gap has considerably widened since FY18 and is expected to be huge in FY20 as well.
While the targeted fiscal deficit (budget estimate) for FY20 is 3.3% of the gross domestic product (GDP), Moody's said with the recently announced corporate tax cuts and lower nominal GDP growth, there could be a 0.4 percentage point slippage, despite significant one-off revenue from the RBI following the review of its economic capital framework.
Stating that the (lower) rate of India's nominal GDP growth over the next few years will have a critical impact on the government's ability to address its relatively weak fiscal position, the agency added that at about 67% of GDP in 2018, India's general government (combined central and state governments) debt is materially larger than the Baa (rating) median of around 52%. Meanwhile, interest payments comprise about 23% of general government revenue, the highest interest burden among Baa-rated peers and three times the Baa median of 8%, it noted.
Moody's warned that a prolonged period of slower economic growth would dampen income growth and potentially constrain the policy options to drive sustained high investment growth over the medium to long term. It said potential GDP growth and employment generation would remain constrained unless reforms were advanced to directly reduce the restrictions on labour and land productivity, stimulate private investment and sustainably strengthen the financial sector.