Downgrading of India's Sovereign Rating

In today’s globalised world, global economies and their big corporate entities are dependent on each other. The global economies not only trade with each other but also seek more and more capital flows for investment. To spur economic growth, world economies compete with each other to seek Foreign Direct Investment (FDI). Countries world over also encourage Foreign Institutional Investors (FIIs) to investment in their respective capital markets. Besides, other than the borrowings from IMF or World Bank, countries also borrow directly from the international financial markets by issuing sovereign bonds. The big business houses also resort to external commercial borrowings from the international financial markets. At the end of June 2020, India’s external debt was US $ 554.5 billion of which commercial borrowing constitute the largest component of external debt, with a share of 38.1%, followed by non-resident deposits (23.9%) and short-term trade credit (18.2%). India’s total public debt as on 2019 was Rs 2,075,316 million dollars accounting for  72.34% of GDP which is estimated to increase to 80% of GDP in the current fiscal year.

To boost investor confidence so as to be able to borrow or to seek FDI, countries involve international credit rating agencies to assess their credit worthiness. The most prominent international credit rating agencies include Standard & Poor, Moody’s and Fitch. The other well-known credit rating agencies include, China Chengxin International Credit Rating Company, Dagong Global Credit Rating, DBRS and Japan Credit Rating Agency. Based on the well laid down methodology, international credit rating agencies assign Sovereign Ratings to global economies which reflects the creditworthiness of a sovereign entity. The rating assigned to a sovereign entity is highly significant in the sense that it provides international investors an insight about the level of credit risk that it may be exposed while investing in the debt of a particular country. In other words, it reveals the ability of a country to service its debt obligations in future. The ratings assigned by the three prominent rating agencies namely, Standard & Poor; Moody’s and Fitch are classified into eight categories viz; High Grade, Upper Medium Grade, Lower Medium Grade, Non-Investment Grade – Speculative, Highly Speculative, Substantial Risk, Extremely Speculative, In default with Little Prospect for Recovery, and In default. The credit rating of high grade or upper medium rating implies either no or very little risk of default by the borrowing countries whereas, lower medium grade rating implies there is a moderate risk and non-investment grade rating signifies high risk of default. The Highly Speculative, Substantial Risk, Extremely Speculative Ratings signifies either very high risk or significant risk of default regarding timely servicing of financial obligations.

India’s sovereign credit rating was recently downgraded by Moody’s to “Baa3” with a negative outlook for the reasons of prolonged period of slower growth, rising debt and stressed financial system. Moody’s has also took rating actions on 11 Indian banks. The other rating agencies viz; Standard & Poor and Fitch have also downgraded India’s rating to investment grade with negative outlook. However, Economic Survey 2020-21 has taken this downgrade with a pinch of salt. The Economic Survey for the first time has minced no words to criticise the downgrade for not looking at India’s strong fundamentals. The Economic Survey noted that there is a clear evidence of a systemic under-assessment of India’s fundamentals as reflected in its low ratings over a period of at least two decades. The economic survey further noted that India has very comfortable position of foreign exchange reserves, as such has a capacity to service its debt obligations in future with ease. It is in view of this fact that the survey makes a strong pitch for a change in the methodology used by the rating agencies to reflect economies’ ability and willingness to meet their debt service obligations and to make it more transparent with greater objectivity.

Given the heavy criticism in the Economic Survey-2020-21 of a downgrade of India’s sovereign credit rating by the international credit rating agencies, there arises a Million Dollar Question, “Are these rating agencies really biased against India? It is not India alone whose sovereign credit rating has been downgraded. Besides India, 21 other emerging economies have suffered either a rating and/ or an outlook downgrade from the rating agencies. The rating agencies report on India’s sovereign rating have noted that the downgrade is not a reflection of its ability to service its debt obligations but due to its relatively low economic growth over a sustained period, deterioration in the fiscal position of the government, very stressed financial sector, and weak implementation of economic reforms since 2017. In the official statement, Moody’s has noted that, “the decision to downgrade India’s ratings reflects Moody’s view that the country’s policymaking institutions will be challenged in enacting and implementing policies which effectively mitigate the risks of a sustained period of relatively low growth, significant further deterioration in the general fiscal position and stress in the financial sector”. Besides, the official document of Moody’s has stated that the down grade is surely in the context of pandemic but not due to the Covid-19 induced economic meltdown. According to Moody’s, ” the pandemic has amplified vulnerabilities in India’s credit profile that were present and building prior to the shock and which motivated the assignment of negative outlook last year”.

India’s overall economic outlook has remained gloomy over some period. Its fiscal deficit which hovered around a threshold level of 3% of GDP till the financial year 2018, thereafter it recorded a sustained deterioration. In fiscal year 2019-20, it increased to 3.5% and due to the fallout of Pandemic, it jumped to 9.5% in the financial year 2020-21as against the consensus 7%.  For the financial year 2021-22, fiscal deficit is pegged at 6.8% and the govt. noted its resolve in the Union Budget to bring down the excess deficit to 4.5% by the financial year 2026. The underperformance of Indian economy is also reflected in its declining GDP which before pandemic had declined from a high of 8.3% in 2017-18 to 4.5% in 2019-20. In the current financial year, it is estimated to contract between 4% to 5% due to the lockdown imposed to control the spread of Coronavirus. The underperformance of Indian economy has led to a serious distress in the financial sector. As of March 31, 2018, provisional estimates suggest that the total volume of  gross NPAs in the economy stands at Rs 10.35 lakh crore. The RBI Governor warned that most likely the bad- loan ratio of banks in the country is  almost going to double this fiscal year. It is also that in 2017, Moody’s has upgraded India’s sovereign rating to Baa2 with a stable outlook, hoping that the reforms undertaken by the government will help in growth momentum. But Moody’s has noted that it failed to effectively implement reforms resulting into deceleration of growth and greater fiscal stress, which it noted, among other things prompted to downgrade India’s rating.

Our policy makers are well within their rights to raise objections to the downgrade by the International Rating Agencies but the fact is that their ratings do matter a lot to the international investors. The countries with higher ratings are able to raise capital through the issue of sovereign bonds comparatively at lower rates of interest from the international financial markets. Besides, such countries are able to outcompete other nations in attracting much needed FDI. But the current downgrade is unlikely to have any immediate impact on the bond spreads of offshore bonds and the exchange rates. However, if we fail to deal with the various economic issues which prompted rating agencies to downgrade our sovereign rating, there is every likelihood that our rating will slip further down. Our immediate concern should be to at least ensure that we remain in the investment grade and in the long run give growth a big push. This among other things would require to gradually lower fiscal deficit to bring it to the threshold level at the earliest. Apart from successfully implementing the reforms already initiated, achieve the targets of disinvestment envisaged in the budget. A big push towards disinvestment of public sector enterprises will help the govt to keep the fiscal deficit under control and at the same time will enlarge the ‘Resource Envelop’ of the government which in turn will enable it to spend more to boost demand which is the need of the hour. Equally important would be to take all measures to deal with the stress with which the financial sector is currently suffering.

Author is Professor in the Dept. of Commerce , University of Kashmir.