Moody’s India Outlook Downgrade Presents An Incomplete Picture, Here’s Why 

Recently, Moody’s downgraded India’s rating due to lower-than-anticipated growth rates and the inability of the government to address some of the long-standing issues that curtail India’s growth rates.

The stock markets clearly didn’t price a rate cut at this junction and the downgrade came as a surprise to many analysts in India.

Indeed, our growth rate has slowed over the last few quarters. We are looking at lower growth in the current financial year and the government is aware of these developments and has already taken several steps to address them.

The fact that we’ve witnessed a historic corporate tax cut, front-loading of bank recapitalisation and a slew of measures suggests the proactiveness of the government in terms of addressing the slowdown.

Therefore, the assessment of the ability of the government is, perhaps, wrong. In fact, we’ve witnessed some of the boldest decisions taken by any government in India’s history ever since the start of Modi 2.0.

It is only fair to expect some of such bold decisions in terms of economic policies soon. The Finance Minister has already indicated the possibility of factor market reforms very soon. Therefore, one can expect many big-bang economic reforms in the next couple of years.

The political economy of India has changed, as, for the first time in 48 years, we have a successive full-majority government, and for the first time ever, we’ve re-elected a government that introduced a series of bold reforms.

All these developments support the hypothesis of several big-bang reforms over the next couple of months.

Therefore, on one hand, we’ve a lot of policy interventions to revive growth in the short run, while there’s a comprehensive long-term agenda of reforms.

This makes the downgrading by Moody’s suspect as their assessment seems to ignore these measures taken.

Indeed, ratings are important, and they do play an important role in guiding investors. However, the fact that leading ratings failed to ascertain the risk associated with mortgage-backed securities during the North Atlantic financial crisis and their recent failure to evaluate the build-up of systemic risks in India’s Non-Banking Financial Companies (NBFC) space makes one question the level of insights such ratings can provide.

The current economic slowdown is indeed precipitated by our tight monetary policy at a time when our banks were stressed. It is imperative to consider the counter factual. That is, the clean up of bad assets with a moderate-to-accommodative monetary policy.

Had the pain of the clean-up been significantly lower, growth would have been higher, and inflation would have been close to the target.

In fact, the reason growth will be weaker in Q2 is precisely because both credit growth and consumption were muted along with poor industrial performance.

Now, an important question is the outlook for the economy over the next financial year, which cannot be independent of the outlook for global growth.

Many anticipate global growth to continue muted in the coming financial year. However, with the possibility of a trade deal between US and China combined with the accommodative monetary policy and pressure on governments to look at fiscal tools to revive growth, global growth is likely to be robust.

Now, the question with respect to India. We’ve witnessed substantial reduction in our repo rates, which have resulted in a reduction in our real repo rates.

Of course, we need to go further with rate cuts, but we’re witnessing a gradual reduction in lending rates by banks.

Therefore, as long as the lending rates continue to be reduced over the next couple of months, growth is likely to be back to 7 per cent levels.

However, it would be critical to address some of the issues that are curtailing credit growth and affecting the transmission of monetary policy.

While growth for the entire financial year may be low, it will still be better when one considers the economic performance during the first half of the current financial year.

With Q1 growth at 5 per cent and as per my forecast, Q2 growth at 4.8-5.2 per cent, we’ve certainly hit bottom.

There are early signs of recovery in the economy as automobile sales have started to pick up and Q2 earnings have been decent for several companies.

The Q2 performance could, however, be because of the corporate tax cut, but even the tax cut is likely to have a positive impact on overall growth for the current financial year.

As things stand, Q3 will be at 5.4-5.8 per cent and we may touch mid-6 per cent growth in Q4, thereby having a lower-than-anticipated growth rate in FY2019-20.

However, given that we’ve started to witness recovery of a cyclical slowdown that originated from the second quarter of FY2018-19, we will be back to a 7-7.5 per cent growth rate in FY2020-21.