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(Photo: Bloomberg)
(Photo: Bloomberg)

Lockdown: India at cliff edge of a rating downgrade

  • Nomura’s views follow Fitch’s warning that the deterioration in fiscal outlook may put pressure on sovereign rating
  • Last week, Fitch revised lower its forecast for India’s FY21 growth to 0.8%

MUMBAI: Nomura on Wednesday said India's sovereign rating is vulnerable to a downgrade. The Japanese securities firm blamed the government's deteriorating debt dynamics and a poor fiscal track record coupled with businesses and the broader economy ravaged by the nationwide lockdown, now in its fifth week, for its warning.

Nomura has cautioned that a downgrade by Moody’s and a negative outlook by Fitch appear likely for India. “India’s Achilles heel on ratings is its parlous state of fiscal affairs and the risk of a sharp deterioration of general government debt from 70% of gross domestic product (GDP) to potentially 75-80% of GDP. A further risk is the deterioration in economic growth, partly intertwined with financial sector concerns," it said.

The views follow Fitch Ratings' warning on Tuesday where it said that deterioration in India’s fiscal outlook as a result of lower growth could put pressure on its sovereign rating. Last week, Fitch had revised lower its forecast for India’s FY21 growth to 0.8%.

Given Fitch’s assessment of debt sustainability and India’s poor fiscal track record, Nomura believes the likelihood of an outlook change to “negative" is elevated.

Nomura believes Moody’s is likely to downgrade India’s rating from Baa2 ‘negative’ to Baa3 ‘stable’ but may wait to get a better handle on the government’s fiscal plans to make a more complete assessment of growth and fiscal impact.

It also thinks that S&P may consider an outlook downgrade, just fiscal deterioration may not be enough of a trigger but would need to be convinced that the ongoing economic pain has structural legs and involves changes to institutional factors. "At the current stage, we judge that an outlook change by S&P is a risk, but we do not believe this is imminent at this stage," Nomura said.

Nomura does not expect a downgrade from Moody’s to Baa3 to significantly surprise the markets and even if Moody’s ratings come in line with Fitch and S&P (even with a negative outlook), it sees only a small and short-lived negative impact on Indian rupee. Overall, Nomura views the ratings risk to Indian currency as a more medium-term factor but in the near term, it thinks global risk sentiment, capital flows and oil prices are more significant drivers of the Indian rupee.

“Potential ratings action could dent prospects for the opening up of India’s bond markets," it said.

According to Nomura, ratings downgrade to sub-investment grade could dent prospects for India bond inflows in the medium term and domestic factors including fiscal slippage and the Reserve Bank of India support for issuance are crucial in the medium term.

Currently, India has a sovereign rating of BBB- with a stable outlook from S&P and Fitch - a grade above the junk category - while Moody’s rates it at the equivalent of one notch above, at Baa2, albeit it changed India’s outlook to negative in November.

With the exception of the surprise upgrade by Moody’s in November 2017, India’s sovereign rating has largely remained stable, with changes limited to outlook. Even in response to the global financial crisis, S&P was the only rating agency to have taken a negative action, again limited to an outlook change from stable to negative. Thereafter, despite elevated fiscal risks, S&P restored the outlook to stable within a year on the back of better growth prospects.

The deterioration of the macroeconomic outlook in the run-up to the taper tantrum led to the next phase of rating action in Q2 2012, when both S&P and Fitch downgraded India’s outlook. However, within a couple of years, they restored India’s outlook back to stable, reflecting an improvement in fiscal parameters and a change in government at the Centre in 2014.

Moody’s has been an outlier in its optimism since 2015. In April 2015, it raised India’s outlook from stable to positive, and following the passage of the goods and services tax (GST) and bankruptcy reforms, it took the surprise step of upgrading India’s sovereign rating by one notch in 2017. However, the optimism for strong growth and stable fiscal dynamics started unraveling, and within two years, by the end of 2019, Moody’s had downgraded the outlook from stable to negative.

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