Mumbai: Almost a year ago, ratings company Moody’s Investors Service Inc. upgraded India’s sovereign debt rating, making India only the second large emerging market (among emerging markets in the G20 group of economies) to have improved its rating in the past five years. Since then, only two more major economies (G20 members) — Argentina and Indonesia — have been upgraded by Moody’s while two others — Turkey and Italy — have been downgraded.

India, meanwhile, has witnessed a massive exodus of foreign investors since the upgrade. According to data sourced from the Institute of International Finance Inc. (IIF), India has witnessed the sharpest non-resident portfolio outflows (equities and debt combined) among major emerging market (EM) economies over the past year.

Clearly, Moody’s upgrade of India’s rating to Baa2 from Baa3, the first such upgrade in 13 years, did not increase capital inflows. One reason is that ratings agencies are often behind the curve and play catch up. Even before Moody’s upgrade, India had already succeeded in reining in inflation, current account deficit (CAD) and fiscal deficit amid low crude oil prices. Thus, portfolio inflows had already surged before Moody’s upgrade.

And after the upgrade, whatever could go wrong has indeed gone wrong. While Moody’s had struck a largely upbeat tone in its upgrade note last year, it had nevertheless mentioned three risks which could move the rating down—increase in external vulnerability, a “material deterioration" in fiscal metrics and slide in banking health. All of these three risks materialized subsequently, in varying degrees.

As Mint’s macroeconomic tracker showed, India’s external vulnerability metrics have deteriorated in recent quarters. India’s CAD continues to widen amid two headwinds—elevated crude oil prices and global trade uncertainties—which have dampened India’s exports.

Over the past year, the outlook on India’s CAD has worsened the most among major emerging market economies. To illustrate, the World Economic Outlook (WEO) released by the International Monetary Fund (IMF) in October 2017 had pegged India’s 2018-19 CAD at 1.5% of GDP (gross domestic product). After a year, in the October 2018 WEO edition, it revised the estimate upwards to 3% of GDP.

The fact that the outlook on India’s current account has worsened the most in the last one year is not surprising given India’s excessive reliance on imported crude oil, compared to other emerging markets.

Apart from external vulnerability, the fiscal outlook has also deteriorated. Moody’s in its note last year had lauded reforms such as goods and services tax (GST) and demonetisation for their potential to “reduce informality in the economy" and to better government finances. However, as noted in a recent Plain Facts column, such measures have not led to any significant improvement in the central government’s finances, with the centre set to miss its 2018-19 fiscal deficit target. The growth in aggregate indirect tax collections of the centre and states has also declined after the introduction of the GST, data shows.

Apart from external vulnerability and fiscal metrics, the third risk that Moody’s had highlighted was banking health. To be sure, the present government has taken some bold steps to resolve the bad-loan problem of banks, such as introducing the Insolvency and Bankruptcy Code, 2016 (IBC). However, the recent public spat between the Government of India and the Reserve Bank of India (RBI) raises concerns whether the government will continue to support the hitherto aggressive measures by RBI. Reports suggest that the government has not been too happy with RBI’s February 12 circular on classification of NPAs (non-performing assets).

Any perceived leniency in dealing with the NPA problem might be perceived negatively by ratings agencies and foreign investors, given that India’s banking sector is already among the weakest among G20 economies.

Besides, cracks are also appearing in some of India’s leading non-banking financial companies (NBFCs). The financial sector troubles do not bode well for India’s investment cycle.

Thus, in the one year since Moody’s upgrade, it seems all the downside risks that the ratings agency had highlighted, have indeed materialized.

One silver lining in recent weeks has been the correction in oil prices. If that sustains, it could brighten prospects for the Indian economy in the short-term. However, unless the engines of exports and investments start firing, growth will remain lopsided, and the economy won’t see a sustained recovery.

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