Moody’s thumbs-down on the Indian economy (its ratings outlook has been revised from stable to negative) hardly comes as a surprise, given India’s plummeting growth and the disarray in the shadow banking or NBFC sector. This marks a turnaround in perception since November 2017, when India’s investment rating was bumped up from Baa3 to Baa2 following the rating agency’s satisfaction with India’s structural reforms — such as implementation of GST and the bankruptcy code. Thereafter, the Baa2 rating has remained with a stable outlook, the ‘credit opinions’ issued in October 2018 and April 2019 sticking to the status quo. The latest outlook revision is a warning that the investment rating may slip, if the government does not take steps to push structural reforms.
Moody’s is one of the Big Three ratings agencies, and global investors do take a serious note of their outlook on a country’s macros, be it the fiscal deficit, current account deficit, inflation, financial stability and growth. Moody’s has been persuaded by a possible slippage in India’s fiscal deficit and growth this financial year being well below 7 per cent. The fiscal and current account deficits, along with inflation, impact return on investment through the exchange rate and interest rate. A higher fiscal deficit is expected to lead to crowding out of private investment. However, taking too rigid a view of these metrics can be misleading.
For instance, a higher fiscal deficit may not lead to a higher interest rate in the short run if private appetite for investment is low. An inflation rate that is persistently low may be a sign of a deflationary economy.
Ratings metrics
In Economic Survey 2016-17, the ratings metrics of Standard & Poor’s have been called into question. China’s ratings were revised upwards in 2016 from A+ to AA-, despite a rising credit-to-GDP ratio and falling growth, whereas India’s has remained stuck at BBB- despite a flat credit-to-GDP ratio and growth that was generally rising at that time. Ratings agencies have erred in assessing both countries and financial institutions in the Western world, which contributed to the GFC.
Yet, there can be no denying that India’s economic and financial crisis is for real. India needs structural reforms to raise its potential output, and there can be a debate on what these ought to be. Agricultural productivity and incomes need to be lifted on the demand side, so that industrial capacity can be be increased. Human development will improve labour productivity, as China has shown. Ratings agencies do not necessarily take these aspects into account.
Published on November 10, 2019