India’s Achilles heel on ratings, according to Nomura, is its parlous state of fiscal affairs. A potential spike in its general government debt from around 70 per cent of GDP to around 75-80 per cent of GDP, it believes, may possibly trigger a reassessment of ratings, particularly for Moody’s.
"There is a moderate likelihood of an increased interest rate burden adding to the pressure of a rating downgrade of the fiscal sub-category. In addition, potential recapitalisation of the banking sector in the eventuality that banks’ non-performing assets (NPAs) once again become unsustainably high adds to the contingent liabilities burden, which could have a negative impact," analysts at Nomura
Earlier this week, Fitch Ratings
had cautioned that India's sovereign rating could come under pressure if there is further deterioration in fiscal outlook as a result of lower growth or fiscal easing. The statement came amid reports of further fiscal easing to support growth over the extended coronavirus lockdown.
India currently has a sovereign rating of BBB- with a ‘stable’ outlook from S&P and Fitch – a grade above the junk category, while Moody’s rates it at the equivalent of one notch above, at Baa2. However, Moody's had changed India’s outlook to ‘negative’ in November 2019.
In response to the global financial crisis (GFC), S&P was the only rating agency to take a negative action, which was limited to an outlook change from ‘stable’ to ‘negative’. Thereafter, despite elevated fiscal risks, S&P restored back the outlook to ‘stable’ within a year on the back of better growth prospects.
The deterioration of the macroeconomic outlook in the run-up to the taper tantrum led to the next phase of rating action in the second quarter of 2012 (Q2-2012), when both S&P and Fitch downgraded India’s outlook. However, the rating was restored to 'stable' in 2014 when the Narendra Modi - led government took charge.
Given the sudden shock to the economy in the backdrop of the pandemic, Nomura believes that the government may temporarily suspend the Fiscal Responsibility and Budget Management legislation (FRBM), and will push the fiscal deficit beyond the 0.5 per cent of GDP that the current fiscal rules allow.
“Consequently, we believe the central government’s fiscal deficit will rise to around 5.1 per cent of GDP in FY21, with considerable upside risk, depending on the quantum of forthcoming fiscal support. With states’ budgets combined, the consolidated fiscal deficit will expand to around 9.5 - 10 per cent of GDP, close to record highs in the recent past. Additionally, lower nominal GDP growth, along with rising contingent liabilities (support to banking sector) are likely to materially raise the public debt-to-GDP ratio,” Nomura cautions.
Note: In the first two columns, red stands for negative rating action and green stands for positive rating action. The rest of the columns are colour-coded according to their impact on ratings, with red standing for negative impact on ratings and green for positive impact. Chart source: Nomura report