Why the Moody's downgrade might not really matter to markets

Indian sovereign debt was last downgraded in June 1998 in the immediate aftermath of the Pokhran nuclear test by the Vajpayee government in May 1998.

June 02, 2020 3:24 IST | India Infoline News Service
On June 01, 2020 Moody’s Investor Services downgraded in India’s sovereign ratings from Baa2 to Baa3. The Baa3 rating represents the lowest level within“Investment Grade” and any downgrade from here would assign Junk Status to India debt. Here is how countries are broadly classified based on ratings by Moody’s.

Category of Rating Rating symbols Sample Country list
Highest (Super Investment grade) Aaa United States, Singapore
Very High (Investment Grade) Aa1 to Aa3 Austria, Finland
High (Investment Grade) A1 to A3 Japan, China
Good (Low Investment Grade) Baa1 to Baa3 India
Speculative ( Junk Grade) Ba1 to Ba3 Russia, Bangladesh

Indian sovereign debt was last downgraded in June 1998 in the immediate aftermath of the Pokhran nuclear test by the Vajpayee government in May 1998. There have been 3 upgrades in between and this marks the first downgrade by Moody’s in the last 22 years.

Month / Year Rating Action Rating Post Action
June 1998 Downgrade to Ba2 Remains in Speculative Grade
February 2003 Upgrade from Ba2 to Ba1 Remains in Speculative Grade
January 2004 Upgrade from Ba1 to Baa3 Speculative to Investment Grade
November 2017 Upgrade from Baa3 to Baa2 Improves in Investment Grade
June 2020 Downgrade from Baa2 to Baa3 Lower in the Investment Grade

What exactly has Moody’s downgraded

The following ratings of the government sovereign debt are likely to be impacted by the Moody’s sovereign downgrade.

•  Long-term Issuer Rating (Foreign and Local Currency), Downgraded to Baa3 from Baa2

•  Long-term Senior Unsecured Debt (Local Currency), Downgraded to Baa3 from Baa2

•  Other Short-term Senior Unsecured Debt (Local Currency), Downgraded to P-3 from P-2

•  Outlook, Remains Negative

Earlier this year, Moody’s had downgraded the outlook for the Indian economy from stable to negative givingthe first indication that Indian sovereign debt was due for a downgrade. Paradoxically, Moody’s was the only rating agency to upgrade India’s sovereign rating in 2017 while S&P and Fitch had desisted from an upgrade. To that extent, this is more of a return to status quo than a rating downgrade.

What is the justification for the rating downgrade?
Moody’s cited 3 key reasons for the rating downgrade which pertains to the current vulnerability of the economy, lack of policy options and the impact on fiscal deficit.
a)  The big casualty of COVID-19 is GDP growth. RBI has hinted at negative GDP growth in 2021 and most brokerages and rating agencies       are also of the same view. According to Moody’s, supply side efforts have not worked due to weak demand.

b)  Weak demand means that policy options are limited. According to Moody’s, monetary room is limited and financial institutions are under         stress. Fiscal policy will have a lagbecause demand will take time to come back due to COVID-19 income effect.

c)  The outcome will be a spurt in fiscal deficit, which is at 4.5% for FY20 and could cross 6% in FY21. Total debt is up from 72% of GDP in         2019 to 84% in 2020. Moody’s is of the view that once global trade picks up, current account deficit (CAD) could also widen.

Will the Moody’s downgrade really impact financial markets?
The way the Nifty and Sensex continued their rally on Tuesday 02nd June, stock markets do not appear overly perturbed. Will the downgrade have an impact on the Indian economy and why are markets not worried?

•   In the current context low growth and high fiscal deficit are a global phenomenon in the post COVID scenario. The shutdown was                  inevitable and global; and India had little choice. It would have been a risk if the de-growth was unique to India.

•  With respect to policy options, the typical approach to growth is always countercyclical. Pump priming entails that you allow fiscal deficit to     overshoot temporarily to support economic growth. That is just what India, and most other economies, are doing.

•  Unlike many other economies that borrow sovereign debt from abroad, the Indian government does not borrow abroad. Even its recent         plan to raise $5 billion via global sovereign bonds was shelved. That makes Indian government largely immune.

•  Corporate borrowings abroad could get impacted but that is only theoretically. Globally, rates are sharply down and asset allocators still         need high return assets like Indian debt. That will ensure the impact of the downgrade on corporate debt will be minimal.

•  Lastly, if the last downgrade of 1998 is any indicator, markets may have reasons to cheer. The Sensex touched 2951 in June 1998 after         the Moody’s downgrade. However, by Jan-2000, the Sensex was at 6150; a return of more than 100% in 18 months.

Moody’s may have reasons for the downgrade. However, in the midst of the pandemic when growth is the first priority, the downgrade is likely to have only limited impact.

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