It’s a bird. It’s a plane. It’s reform.
Reforms are at the centre of the Indian economy’s turmoil right now—reforms that were slow to work, and reforms that didn’t work.
Perhaps a reality check on the reforms agenda led to Moody’s Investors Service lowering the outlook on India’s sovereign rating from stable to negative. Note that the rating itself hasn’t been lowered, but India is at a greater risk of getting downgraded back to borderline investment grade now. So what changed in the two years since Moody’s upgraded India’s sovereign rating to Baa2 from Baa3 in 2017, citing, among things, reforms?
India’s gross domestic product growth has fallen to 5% from 8%. Both business and consumer sentiments have dropped, as shown by the surveys of India’s central bank. Banks are still saddled with a huge pile of bad loans and non-banking financial companies (NBFCs) have found themselves in the middle of a liquidity crisis. In short, the economic engine has slowed dramatically and the fuel from its financial sector is running out, too. Moody’s has recognized all this. “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 in its note. These risks have also been flagged by several economists and analysts over the past few months. The key question is why has India found itself in such a vulnerable position.
Private investment growth has been tepid and the stroke of demonetization accelerated the economic slowdown. Seven months following the November 2016 move, the government in July 2017 put in motion the goods and services tax (GST).
While the cash-dependent informal sector consisting of small businesses suffered, NBFCs found themselves in a liquidity crunch. So, the twin balance sheet problem of over-leveraged corporates and weak banks has now become a triple balance sheet problem. “Even as the resolution of bank and corporate balance sheet issues continue, the economy is now burdened with weak shadow banks," Nomura Financial Advisory and Securities (India) Pvt. Ltd said in a note.
Gains from reforms like GST and the insolvency code have been rather slow, and Moody’s realized the positive effects are still far off. Meanwhile, the damage to the economy has deepened. What is more significant is that the rating agency believes more reforms are unlikely to follow. “Prospects for economic and institutional reforms that would lift and maintain growth at high rates have diminished," Moody’s said.
The lowering of the rating outlook may not be very significant, but it indicates that analysts and the market miscalculated the impact of reforms by the government. The markets are waking up now to this harsh reality and Moody’s has just sounded the warning bell.