Home >News >India >How govt can roll out a stimulus without upsetting  rating  agencies

As covid-19 keeps factories shuttered and workers at home, global rating agencies have been taking a close look at how India’s economy will weather the pandemic. Warnings of an adverse change in India’s rating outlook, or, worse, a rating downgrade, are already flashing for India. All three global rating agencies have slashed their forecasts for the country’s gross domestic product (GDP) growth massively.

Fitch Ratings last month had warned that a “further deterioration in the fiscal outlook as a result of lower growth or fiscal easing could pressure the sovereign rating in light of the limited fiscal headroom India had when it entered this crisis."

But should we be worried at all? It does not help that India has the lowest investment grade rating of BBB- from both S&P Global Ratings and Fitch Ratings, with the outlook being stable.

Moody’s Investor Service rates India a notch above at Baa2, (its comparative rating to S&P’s and Fitch’s BBB- is Baa3), but with a negative outlook.

“I don’t think you can ignore rating agencies because what they do has implications on foreign investment, not just portfolio but, to some extent, FDI (foreign direct investment) as well," said Abheek Barua, chief economist at HDFC Bank Ltd.

On the chopping board
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On the chopping board

Foreign investors such as pension funds, sovereign wealth funds and others are bound by rules that do not allow them to buy non-investment grade paper, also referred to as junk bonds.

As a cut in rating will invariably strip India’s securities of investment grade, this would mean losing a swathe of money immediately.

One can argue that foreign investors are fleeing emerging markets, including India, in the wake of the pandemic; and so, keeping ratings safe shouldn’t be a priority. Even so, the investors mentioned above take a long-term view, and losing them could mean prolonged pain for India. Also, rating downgrades, or even outlook cuts, tend to roil financial markets, at least briefly. We can ill-afford another market meltdown right now, given that the domestic bond markets are already under a risk aversion freeze. A sentiment blow through a rating or an outlook change will make the pain even more severe.

That said, it would be harsh to starve the economy of a stimulus because of the fear of a rating downgrade. The potential long-term adverse outcome of the absence of a stimulus in times of a shock such as covid-19 on the economy is itself detrimental to ratings.

Analysts believe that policymakers can make rating agencies warm up to India by being transparent on fiscal health. In other words, a large fiscal stimulus can still be rolled out because that’s really the need of the hour; but it can be communicated clearly what the new fiscal glide path will be, and why the stimulus is necessary for the long-term health of the economy.

Laying out a road map for reforms, along with a stimulus, and convincing investors and rating agencies that India would adhere to it would be another important step. Recall that Moody’s upgraded India on the back of confidence from tax reforms. Another way of keeping rating agencies happy is a transparent picture of the fiscal health. At a time when every country has been impacted by the pandemic, agencies are unlikely to pull up India for having a sharp increase in fiscal deficit. What would matter is to make the fiscal deficit count by effective implementation, said Barua.

Nomura Financial Advisory and Securities (India) Pvt. Ltd noted that besides fiscal health and economic growth, ratings also reflect certain long-term sticky parameters.

Even on economic parameters, agencies tend to use an average over a period rather than one standalone year.

Indeed, both S&P and Fitch have kept India’s rating and even the outlook unchanged for more than five years now.

India’s policymakers may not be able to ignore rating agencies since investors won’t do so.

A credible fiscal plan and a honest, even if ugly, picture would go a long way in not just healing the economy but also keeping ratings unhurt.

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