India’s soaring equity indices needed a reality check on the economy. And it came through Moody’s Investors Service’s downgrade of India’s rating outlook.

Moody’s has lowered the outlook on India’s rating to negative from stable. The sovereign rating continues to be at Baa2. What this means is that India is at a greater risk of losing its Baa2 rating now and will come full circle to being borderline investment grade.

“The outlook change is a negative surprise, but Moody’s was the only rating agency to have upgraded India’s ratings (to Baa2 from Baa3 in November 2017," said Nomura.

Understandably, equity indices have slipped into the red, while bond yields have risen. But the reaction is not sharp enough. That is because some in the market had seen this coming. After all, Moody’s reasons behind this is already well acknowledged. Moody’s cited that the ongoing credit crunch involving non-bank finance companies won’t be resolved quickly and the government has no firepower left to battle a deepening economic slowdown. “The drivers of the economic deceleration are multiple and mainly domestic. In the context of a prolonged period of weak investment, private consumption has slowed, driven by financial stress among rural households and weak job creation," the rating agency said.

Analysts have flagged these concerns, saying all this makes Indian markets less appealing to global investors.

What does this rating downgrade imply?

The government’s intentions to borrow through a sovereign dollar issue becomes even more challenging now. Considering tepid tax revenues, this means local currency borrowings will remain high or perhaps increase. Bond yields rose 5 basis points on this concern.

To be sure, the rating is still retained at Baa2 by Moody's. Also, the rating by other two agencies is still at BBB(-) which is borderline investment grade. Both Fitch Ratings and S&P have kept outlooks on their ratings unchanged at stable.

The key question is whether they would also cut their outlooks to negative. If they do, India’s efforts to attract foreign capital will take a bigger hit.

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