Moody's downgrade: Expect bouts of correction; sell-off in markets unlikely

Ambareesh Baliga. Photo: Twitter (@ambareeshbaliga)
Moody’s Investor Service on Monday downgraded India’s sovereign rating to Baa3 from Baa2, with a negative outlook. The rationale for Moody’s first such downgrade in two decades was “policy-making institutions will be challenged in enacting and implementing policies which effectively mitigate the risks of a sustained period of relatively low growth, significant further deterioration in the general government fiscal position and stress in the financial sector”. In short, we have been pushed to a notch above “junk grade”.

The downgrade came after market hours, so one wonders if this might lead to a sell-off on Indian bourses on Tuesday, after a stupendous four-day rally taking the Nifty closer to the 10,000 level. I don’t think Moody’s downgrade will have a major effect on markets, as the new rating is on a par with the S&P’s and Fitch ratings of India at BBB-. However, the outlook labelled as “negative” could sway the sentiment in the short term.

The Moody’s downgrade was anticipated for a while, especially amid fears that the Covid-19-related lockdown might slow down the already tottering economy. The country’s gross domestic product (GDP) growth in FY20 is estimated at 4.2 per cent, the slowest rate since FY09. For the current year (FY21), Moody’s expects India’s economy to contract 4 per cent. With five consecutive lockdowns – ranging from two-and-a-half to three-and-a-half months in a few locations and claimed to be one of the strictest globally – was bound to have an adverse impact on the economy along with diluted fiscal prudence. It’s been officially accepted by none other than the Reserve Bank of India Governor that the Indian economy will contract in FY21, though market estimates vary between -1 per cent and -5 per cent. Fiscal deficit could be upwards of 7 per cent owing to lower revenues and higher expenses.

Incidentally, Moody’s had upgraded India’s rating to Baa2 in November 2017 on expectation that the government would effectively implement key reforms, but it has now drilled holes in the government claims by stating that “implementation of key reforms promised by Prime Minister Modi’s first term has been relatively weak and has not resulted in material credit improvements, indicating limited policy effectiveness”.

With a gradual lifting of the lockdown, except in containment zones, we should see economic activity buzzing again. Though this quarter is mostly “washed out”, we may see some semblance of sanity in the next quarter. The rural economy hasn’t been affected to a large extent, thanks to the recent good harvest. Now, with a normal monsoon forecast, that could boost consumption in the rural economy. The moot question, however, is whether we will bounce back in the third quarter of FY21 based on the “stimulus” package being rolled out in various phases, with yet another instalment coming on Monday. The most important factor, I believe, would be the ingenuity and the “indefatigable spirit” of the Indian entrepreneur, echoing Prime Minister Narendra Modi’s call for “Atmanirbhar Bharat” (self-reliant India) despite being in the most unenviable position.

And stock markets generally discount an outcome a couple of months in advance. We may have bouts of correction, but markets seem to have witnessed the bottom in March 2020 unless we see a more ferocious second wave resulting in a fresh lockdown.
The author is an independent market expert. The views expressed here are his own

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