Moody’s Cuts India’s Credit Ratings Outlook To Negative From Stable: Full Text
Pedestrians walk past stores during the festival of Dhanteras in the Zaveri Bazaar in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)

Moody’s Cuts India’s Credit Ratings Outlook To Negative From Stable: Full Text

Moody’s Investors Service cut India’s credit ratings outlook to negative on growing concerns that a prolonged economic slowdown will lead to a rise in debt.

Watch | Moody’s Gene Fang Explains The Rationale Behind A ‘Negative’ Outlook

Here’s the full text of Moody’s statement:

Moody's Investors Service ("Moody's") has today changed the outlook on the Government of 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.

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.

Also read: Moody’s Sees Prolonged India Credit Crunch That May Worsen

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.

A full list of affected ratings is provided towards the end of this press
release.

RATINGS RATIONALE

RATIONALE FOR CHANGING THE OUTLOOK TO NEGATIVE FROM STABLE

RISING RISK OF AN ENTRENCHED GROWTH SLOWDOWN AS MEDIUM-TERM REFORM PROSPECTS HAVE DIMMED AND STRESS IN THE FINANCIAL SECTOR HAS INCREASED

India's economic growth has slowed materially, with real and nominal GDP growth falling to 5% and 8% year on year in April-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% 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 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% from 30%. 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% and 11% 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 labor 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.

PROSPECTS FOR THE DEBT BURDEN TO DECLINE HAVE DIMINISHED, WITH RISKS THAT IT MAY RISE GRADUALLY

The rate of India's nominal GDP growth over the next few years will have a critical impact on the government's ability to address its relatively weak fiscal position.

At about 67% of GDP in 2018, India's general government (combined central and state governments) debt is materially larger than the Baa median of around 52%. Meanwhile, interest payments comprise about 23% of general government revenue, the highest interest burden among Baa-rated peers and three times the Baa median of 8%.

Under Moody's assumption of a slight pick-up in GDP growth, scope for the government to narrow the budget deficit will remain very limited. For instance, with the recently announced corporate tax cuts and lower nominal GDP growth, Moody's now expects a central government deficit of 3.7% of GDP in the fiscal year ending in March 2020 (fiscal 2019), marking a 0.4 percentage point slippage from its target despite significant one-off revenue from the special RBI dividend payment. Government disinvestment (asset sales) could fill some of the gap between actual and expected deficits; however, budgeted targets have not always been met in years past. State deficits will likely be at or very close to the 3% of GDP cap. A deeper liquidity squeeze that threatened the solvency of some NBFIs could give rise to some fiscal costs from government support to some institutions.

In this context, Moody's analysis shows that the outlook for the debt burden is significantly dependent on trends in nominal GDP growth. Indeed, India's historically high rate of nominal GDP growth was an important driver of a declining debt burden in the past, from above 80% of GDP in the early 2000s to about 67% in 2010. Now, under nominal GDP growth of around 11%, which Moody's broadly projects as its baseline over the next few years, the debt burden will remain around 68% of GDP.

The downside risks to growth explained above point to risks that, instead of falling as expected previously, the debt burden rises gradually. In that scenario, India's already very weak debt affordability would weaken further, constraining fiscal flexibility even more. If such developments were to encourage greater reliance on state-owned enterprises to meet the country's need for social and physical infrastructure, the sovereign's contingent liability risks would rise commensurately.

RATIONALE FOR AFFIRMING THE Baa2 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.

With nominal GDP of $2.7 trillion in 2018 India's economy is the largest among Baa-rated sovereigns. The Indian economy has been supported by its very large domestic market, which has provided consistently strong domestic demand, fueled by rising incomes, which has historically helped to shelter it from the impact of external demand shocks. Nonetheless, although at currently slower rates India's growth still remains high by international standards, weak infrastructure, rigidities in labor and product markets, and ongoing asset quality challenges in the financial system continue to constrain the economy's potential.

At the same time, a large pool of domestic private savings, available to finance government debt, partly mitigates the sovereign's fiscal risks posed by high government debt and weak debt affordability. High savings have enabled the government to issue long maturity debt, over 90% of which is owed to domestic institutions and denominated in local currency. As a result, despite its large fiscal deficits, India's gross financing requirements are moderate and relatively insulated from external financing and exchange rate risk. The longer maturity profile of government debt, averaging close to 10 years, also lowers the impact of interest rate volatility on debt servicing costs.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Environmental considerations are material to India's rating, as the country is vulnerable to climate change. For example, monsoon rains are critical for India's agricultural sector, given that almost half the country's farm land is not irrigated. Half of India's overall consumption comes from the rural sector and many rural incomes are dependent on agriculture. The magnitude and dispersion of seasonal monsoon rainfall continue to influence agricultural sector growth, food inflation and rural household consumption. As a result, droughts can create economic, fiscal and social costs for the sovereign. Elevated levels of pollution and rising concerns around water scarcity and
management, also present environmental risks.

Social considerations are material to India's credit profile, mainly related to demographics driven by India's young and growing working-age population. The United Nations estimates that India's working age population (15 to 64 years old) will continue to rise from about 66% of the total in 2018 to about 68% in 2030-40. Meanwhile, 6 to 8 million youths will enter the labor force every year through 2030. This creates both opportunities, through a higher contribution of labor to potential growth, and social challenges, if job creation does not keep pace with India's working age population growth.

Governance is material to India's credit profile. The country's scores are moderate on institutional factors, as measured by the Worldwide Governance Indicators, reflecting moderate government and policy effectiveness.

WHAT WOULD CHANGE THE RATING UP

The negative outlook indicates that an upgrade is unlikely in the near term. Moody's would likely change the rating outlook to stable if the likelihood that fiscal metrics would stabilize and improve over time increased significantly. This would probably result from renewed indications that economic and institutional reforms would support sustained, strong investment and GDP growth, and broaden the government's revenue base over the medium term. In particular, at this juncture, a credible and durable stabilization of the non-bank financial sector that reduced the possibility of negative spillovers to banks and restored strong credit provision to productive sectors
would be credit positive.

WHAT WOULD CHANGE THE RATING DOWN

Moody's would likely downgrade India's ratings if its fiscal metrics were increasingly likely to weaken materially. This would probably happen in the context of a prolonged or deep slowdown in growth, with only limited prospects that the government would be able to restore stronger growth through economic and institutional reforms. A marked and long-lasting weakening in the health of the financial sector would both raise the associated fiscal costs should the government need to support some institutions and increase the risk that growth remains too low to prevent a rise in the debt burden.

GDP per capita (PPP basis, US$): 7,859 (2018 Actual) (also known as Per Capita
Income)

Real GDP growth (% change): 6.8% (2018 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 2.9% (2018 Actual)

Gen. Gov. Financial Balance/GDP: -5.9% (2018 Actual) (also known as Fiscal
Balance)

Current Account Balance/GDP: -2.1% (2018 Actual) (also known as External
Balance)

External debt/GDP: 20.0% (2018 Actual)

Level of economic development: High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 04 November 2019, a rating committee was called to discuss the rating of the India, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/ framework, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has materially increased.

The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in
this credit rating action, if applicable

LIST OF AFFECTED RATINGS

Affirmations:

..Issuer: India, Government of

....Long-term Issuer Rating (Foreign and Local Currency), Affirmed Baa2

....Senior Unsecured Regular Bond/Debenture (Local Currency), Affirmed Baa2

....Other Short-Term Rating (Local Currency), Affirmed P-2

....Outlook, Changed To Negative From Stable

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