Moody’s Investors Service has changed the outlook on India’s ratings to negative from stable and affirmed the Baa2 foreign-currency and local-currency long-term issuer ratings. Moody’s also affirmed India’s Baa2 local-currency senior unsecured rating and its P-2 other short-term local-currency rating. The Baa2 rating reflects India’s large and diverse economy and stable domestic financing base for government debt, balanced by its high government debt burden, weak infrastructure and a fragile financial sector. Moody’s decision to change the outlook to negative reflects increasing risks that economic growth will remain materially lower than in the past, partly reflecting lower government and policy effectiveness at addressing long-standing economic and institutional weaknesses than Moody’s had previously estimated, leading to a gradual rise in the debt burden from already high levels. While government measures to support the economy should help to reduce the depth and duration of India’s growth slowdown, prolonged financial stress among rural households, weak job creation, and, more recently, a credit crunch among non-bank financial institutions (NBFIs), have increased the probability of a more entrenched slowdown. Moreover, the prospects of further reforms that would support business investment and growth at high levels, and significantly broaden the narrow tax base, have diminished. If nominal GDP growth does not return to high rates, Moody’s expects that the government will face very significant constraints in narrowing the general government budget deficit and preventing a rise in the debt burden. The Baa2 rating balances the country’s credit strengths including its large and diverse economy and stable domestic financing base for government debt, against its principal challenges including high government debt, weak social and physical infrastructure and a fragile financial sector. India’s long-term foreign-currency bond and bank deposit ceilings remain unchanged at Baa1 and Baa2, respectively. The short-term foreign-currency bond and bank deposit ceilings remain unchanged at Prime-2. The long-term local currency bond and deposit ceilings remain unchanged at A1. India’s economic growth has slowed materially, with real and nominal GDP growth falling to 5 per cent and 8 per cent year-on-year in April to June 2019 respectively. Moody’s estimates that the growth slowdown is in part long-lasting. Moreover, compared with two years ago when Moody’s upgraded India’s rating to Baa2 from Baa3, the probability of sustained real GDP growth at or above 8 per cent has significantly diminished. Rather, the downside risks to the growth outlook have increased as prospects for economic and institutional reforms that would lift and maintain growth at high rates have diminished. Stress among NBFIs, with the possibility of a more severe credit crunch that would affect credit supply, both directly and through linkages with non-banks and banks, adds to the downside risks to the medium-term growth outlook. The drivers of the economic deceleration are multiple and mainly domestic. In the context of a prolonged period of weak investment, private consumption has slowed, driven by financial stress among rural households and weak job creation. Moody’s does not expect the credit crunch among NBFIs, major providers of retail loans in recent years, to be resolved quickly. With public sector banks still dealing with the legacy of non-performing loans accumulated at the beginning of the decade, credit supply is likely to remain impaired for some time, compounding the income shocks. With a per-capita income of around 7,900 dollars on a purchasing power parity (PPP) basis in 2018, Indian households’ capacity to absorb such negative shocks is limited. In recent months the government has responded to the growth slowdown with a series of measures aimed at stimulating domestic demand. These include income support to farmers and low-income households, help for stressed industries including autos and NBFIs, and a broad corporate tax cut that reduced the base rate to 22 per cent from 30 per cent. Meanwhile, the Reserve Bank of India has repeatedly cut the policy rate, by a cumulative 135 basis points since February 2019. Although Moody’s expects these measures to provide support to the economy, they are unlikely to restore productivity and real GDP growth to previous rates. Moreover, the multiple facets of the slowdown and structural weaknesses in the real economy and financial system that it reflects point to further downside risks to Moody’s expectations that real and nominal GDP growth will rise towards 6.6 per cent and 11 per cent respectively over the next year. In turn, a prolonged period of slower economic growth would dampen income growth and the pace of improvements in living standards, and potentially constrain the policy options to drive sustained high investment growth over the medium to long term. Looking forward, potential GDP growth and employment generation will remain constrained unless reforms are advanced to directly reduce restrictions on the productivity of labour and land, stimulate private sector investment, and sustainably strengthen the financial sector. Moody’s considers the prospects for effective implementation of such reforms to have diminished since its upgrade of India’s sovereign rating in 2017. In the absence of such reforms, structural constraints on productivity and job creation will weigh further on India’s sovereign credit profile.
