Large stimulus may attract sovereign rating downgrade, say experts

Sme of the fiscal concerns can be addressed by the rise in taxes on petrol and diesel. For now, the extra cost is to be incurred by the oil marketing companies
The markets are eagerly awaiting a stimulus package from the government, but are also trying to second-guess if the resultant fiscal deficit widening would adversely affect the country rating.

A country rating is important for everybody concerned. Borrowing costs in the overseas markets, both for the country, and the firms from that country get impacted if the sovereign rating is tweaked. Global rating agency S&P and Fitch have India’s ratings at BBB-, one notch above junk. But Moody’s has India’s rating at Baa2, which is one notch above its equivalent in S&P and Fitch. Moody’s had lowered India’s rating outlook to ‘negative’ in November 2019.

The core contention seems to be that India’s general government debt, or the debt of the Centre and states combined, is over 70 per cent of the gross domestic product (GDP) already. And this, according to the International Monetary Fund (IMF) does not give much of a scope for India to carry on with a heafty stimulus package. So far, India has infused 0.8 per cent of the GDP as a stimulus, but that is tiny in comparison with 10 per cent of the US.

“India is not a country with ample fiscal space,” said Vitor Gaspar, director, fiscal affairs department, IMF during the time of the release of its Fiscal Monitor report in mid-April.

“But a health emergency takes precedent and the fiscal support needed is quite substantial, but it is temporary, and the pandemic will be, someday, a thing in the past,” Gaspar had said.

But such a stimulus has not come yet, and market participants such as Jayesh Mehta, head of treasury at Bank of America, are expecting that any such stimulus measures can come only when the lockdown is lifted so that the money is utilised well.

There are now expectations that the stimulus should be at least 2-3 per cent of the GDP, which would push the fiscal deficit to 10-10.5 per cent, according to experts.

That is a red zone for the rating agencies, even as they are mindful of a necessary fiscal expansion due to Covid-crisis.

Rating agency S&P, in a note released on April 16 had said any sovereign rating action would not be influenced automatically by the slowdown and the fiscal situation arising due to Covid-19.

Covid-19 will affect economic growth, fiscal balances, debt burdens, the health of the financial sector, and the access to external liquidity of many sovereigns with different credit characteristics. While the negative dynamics may lead to the conclusion that such shocks must lower sovereign ratings across the board, but the ratings would go beyond the headline items, S&P had assured as it saw the slowdown as temporary, even as it could be the worst downturn since the Great Depression nearly a century ago.

The global economic recovery should start in late 2020 and pick up the pace in 2021.

“Our sovereign criteria are designed to allow ratings to withstand short-term fluctuations within different economic cycles. The analytical judgment we use in evaluating the different characteristics of each sovereign, including its room to maneuver and the policy flexibility it possesses to defend the economy is an important factor in our analysis of such fluctuations,” the agency had said.

The rating agency did not say specifically about India. In fact, it responded to a Business Standard query on the issue saying, “we do not comment on the timing of our reviews or speculate on any potential future changes to ratings.”

Other international rating agencies Fitch and Moody’s did not respond to Business Standard queries on the same issue.

Despite the elbow-space being considered by the rating agencies, economists are already betting that India is prime for a potential rating downgrade, at least from Moody’s which has one notch higher rating for the country than the others.

“In our view, there is a rising risk of an imminent downgrade by Moody’s (to Baa3 ‘stable’ from Baa2 ‘negative), bringing it on par with S&P and Fitch, both of which rate India at BBB-,” wrote Nomura analysts Sonal Varma and Aurodeep Nandi in a note on April 29.

“We also see a risk that Fitch will change India’s outlook to ‘negative’ due to deteriorating debt dynamics and its assessment that India has a poor fiscal track record. Meanwhile, S&P’s assessment appears hinged on institutional factors that may change more slowly,” according to Nomura.

“India’s Achilles heel on ratings,” Nomura analysts noted, “is its parlous state of fiscal affairs and the risk of a sharp deterioration of general government debt from Rs 70% of GDP to potentially Rs 75-80% of GDP.”

DBS economist Radhika Rao also raised a similar concern around the rising deficit.

“The need for a strong support package in midst of a sharp slowdown in growth as well capital infusion to recapitalize financial institutions, will weigh on the fiscal math. Higher contingent liabilities might be accompanied by a wider fiscal deficit, while slower growth makes public debt ratios look adverse,” Rao noted.

However, some of the fiscal concerns can be addressed by the rise in taxes on petrol and diesel. For now, the extra cost is to be incurred by the oil marketing companies.

The increase in petrol and diesel taxes by $21/barrel and $27/ barrel respectively will result in the government’s tax collection increasing by about $21 billion if the tax hike is maintained for the full year, Moody’s noted.

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