BBB-: is it sufficient to keep the Indian economy going? An economic and fiscal analysis of the possible repercussions the Indian economy will face as the danger of a credit rating downgrade hover above its head.
A sovereign ‘credit rating’ is the individual assessment of the creditworthiness of a country- evaluating the risks attached to investing in a nation given its debt positioning. Put into perspective these ratings can be broadly divided into two grades namely, ‘investment grade’ or ‘junk grade’. An investment-grade rating (BBB- and above) signifies a low risk of default of a municipal or a corporate bond while the junk or speculative-grade (below BBB-) denotes higher volatility of the bond in the given economic conditions.
To put this into perspective, the credit rating of a country makes a judgment on the security of the government treasury bonds. Since this grade determined by rating agencies takes into account a plethora of factors- the level of government borrowing and national debt, prospects of economic growth, etc.- it determines the ability of the country to repay its principal amount along with requisite interest payments. Leading financial institutions that invest in equity and bonds throughout the world follow a rigid policy of limiting their bond investments to investment-grade only. A loss of such investment-grade rating causes a loss of faith in the country’s credibility- it can trigger a global sell-off of the country’s bonds resulting in an outflow of funds from the equity markets clubbed with a higher cost for its future borrowings Thus, maintaining an investment-grade rating is crucial for a country to maintain its foreign investments and borrowing charges. A rating downgrade to the junk grade causes turmoil in the debt and equity markets of the nation and is therefore deemed as a ‘credit rating crisis’.
Since the 1991 crisis, India has played host to a variety of foreign investors through Foreign Direct Investment (FDI). The country’s potential for foreign investment and market growth over the years has lured various investors and has earned an investment-grade rating by the three most accredited rating agencies, i.e. Standard & Poor, Fitch, and Moody’s. However, in the light of recent economic activities, ranging from demonetization to the implementation of GST and now COVID-19, the economic growth and fiscal balances of the country have taken major blows raising questions over the credit standing of the country.
A thriving nation with an estimated population of 1.37 billion people, India boasts of being the fastest growing economy in the world with a Gross Domestic Product (GDP) growth rate of 7.4% in the 2019 fiscal year. However impressive this seems, these numbers divert our attention from the fact that the current Indian economy faces a declining GDP with the National Statistics office producing an 11-year low growth rate of 4.5% in the second quarter of the fiscal year 2020. This deteriorating growth has had a direct impact on the debt dynamics of the government with 75% of its GDP being financed by debt. As the nation progresses into phase 4 of the lockdown, the
withering debt dynamics of the country point towards a possible downgrade of the sovereign rating to the junk grade.
India entered the COVID-19 crisis with limited fiscal space. The pandemic has forced governments across the world to announce large fiscal support packages. As such, most nations will see wider fiscal deficits and higher public debt. In India’s case, its poor track record in maintaining fiscal discipline may highlight the reason behind such downgrade by various credit rating agencies. The government has shown its inefficiency to meet its fiscal deficit and debt-to-GDP ratio targets in the past as well.
According to Fitch, there is an expected fall in the real GDP growth to 0.8% in FY21 from 5.6% estimated in December by the finance ministry. Additionally, India’s ratio of public debt to GDP is expected to rise to 77 percent in the current financial year from 71 percent prior to the virus outbreak. This is well above the BBB median of 42 percent of Fitch Ratings. India’s relatively robust external position, because of falling oil prices, and shifting of manufacturing industries from China, is helping to offset its comparatively weaker fiscal condition.
Additionally, India’s economic outlook faces risks from the health of its banking and non-banking sectors. The pandemic has further aggravated the challenges faced by these institutions. Systemic failures in these institutions have been visible previously as well at the time of the takeover of Yes Bank and the fiasco of IL&FS to pay back its debts. Prolonged financial-sector weakness could weigh on credit growth, economic output, investment, and productivity.
Furthermore, the downgrade would mean that India’s borrowing would become increasingly difficult in the international markets. The debt interest rates would be high due to a greater probability of default and an already burdened fiscal deficit of 7.03 Lakh crore will be strained further. The government will have to increase the interest rate payments on Government Bonds for people to buy them. As of the financial year 2019-2020, the government had to take an additional loan of 6 Lakh Crores (40% of the government’s annual revenue) to fulfill interest obligations. Breaking this into simple terms, out of every 100 Rupees the government earns, it has only 60 Rupees to effectively use for poverty alleviation. An increase in this interest would further reduce developmental capabilities and hamper the scope of increasing revenue in order to pay back loans.
This slump could lead to a trickle-down effect- the economy could also be excluded from the FTSE World Government Bond Index (WGBI) which will mean a fall in international recognition of nationally recognized bonds and perhaps result in a rise in interest payments on the same. This will put a financial strain on the government’s ability to raise finances through such loans.
Plugging this gap in fiscal deficit and attempting to escape the vicious cycle of interest payments would inevitably see the government increase taxes. This increase in taxes will be accompanied by inflation at a time of global recession. The rupee is very likely to depreciate, resulting in expensive oil imports and that of other essential commodities. This would in turn make everything expensive- life would already be tough for citizens who have recently undergone a nationwide lockdown. Furthermore, the RBI will have to increase the repo rate in order to control inflation and will hence make commercial bank loans expensive, inconvenient, and unrealistic for a debt seeking population. In an already stretched financial condition, the middle class Indian, who is now out of savings will have a tough time securing credit and even if the credit is secured, it will be much more expensive.
While the downgrade to a junk grade seems likely in theory, it is not going to follow through practically. A rating downgrade for India will not only have an adverse impact on the Indian economy, but also the entire world. As highlighted in the aforementioned paragraphs, the paramount repercussions this downgrade is going to have, India has taken up a large degree of lobbying tactics to prevent the same. The growing influence of the Indian lobby- which includes giving in to the whims and fancies of countries along with choosing the right nations to form alliances with- will prevent this credit rating downgrade.
Furthermore, as the world looks at India as a catalyst to drive global economic growth, a credit rating downgrade will make a large number of investors and other countries vulnerable and at a huge loss. As investors will pull out from profitable investments, India will also reduce expensive imports from countries (India is a major importer for many countries like the USA, China, etc.) as its growth rate slows down and is likely to drop to a less than 1% figure. This leads us to the conclusion that the repercussions for the world economy as well as for India are monumental when it comes to the downgrade- leaving both sides worse off.
Additionally, these rating agencies- S&P, Moody’s, etc – which are going to be responsible to give a new rating to India are American concerns. At this point in time, the pull of the Indian-American lobby becomes instrumental. During the period of a pandemic, the United States along with many other countries is dependent on India for its supply of vital medicines and medical equipment- penicillin, hydroxychloroquine, and paracetamol formulations amongst others. India has the upper hand in this emergency situation and can stop the supply of any of these if its demands are not fulfilled leaving the agencies on cross paths.
It is also a commonly known fact that the countries that are availing the services of the rating agencies are generally the same ones paying for them. This often leads to manipulations and more optimistic ratings being given. An optimistic rating, in this case, refers to credit rating agencies awarding a higher rating to countries than what they deserve. The impact of the lobbying tactics in the rating of a country (as mentioned in the previous paragraphs) further showcases the imperfections that exist in the credit rating market.
In conclusion, while the country faces a grave possibility of a credit rating downgrade, the government initiatives suggest otherwise. However much probable this degradation might seem, the economy has recovered from far worse situations historically like the 1991 fund crisis and the 2016 demonetization scheme. Irrespective of the dire state the Indian economy has been in, it has never defaulted on its debt highlighting the creditworthiness and the comfort that the country has with respect to its Balance of Payment- further aiding our conclusion that India will be able to evade this credit rating crisis. This leaves us to see how the illustrious 20 Lakh Crore Rupees relief package unravels for the nation and the fiscal direction in which it takes the country.
Written By: – Sanya Puri
(Sanya is a First-Year B.Com. (Hons.) Student of Shri Ram College of Commerce)