Sovereign rating: Economists shrug off downgrade fear amid Covid crisis

Unprecedented crises, they stress, warrant elevated government spending to rekindle growth impulses fast and protect both lives and livelihood, while fiscal hawkishness is best reserved for normal times.

As the pandemic has strained finances of both the Centre and states, India may be staring at a possible downgrade of its sovereign rating or outlook. But economists caution the government against holding back more demand-side stimulus measures to reverse a slide in growth for fear of potential rating action.

Unprecedented crises, they stress, warrant elevated government spending to rekindle growth impulses fast and protect both lives and livelihood, while fiscal hawkishness is best reserved for normal times.

Thomas Rookmaaker, director (Sovereign Ratings) at Fitch Ratings told FE: “The projected medium-term fiscal path after the pandemic will play an important role in our assessment of India’s sovereign rating. We expect government debt to rise in FY21 and FY22, but the government may tighten fiscal policy again once the pandemic is under control.”

Nomura chief India economist Sonal Varma said there is a growing risk of an imminent rating downgrade by Moody’s to Baa3 with ‘stable’ outlook from the current Baa2 ‘negative’, bringing it on a par with S&P and Fitch, both of which rate India at BBB-, the lowest investment-grade rating.

“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,” Varma said.

She forecast the Centre’s fiscal deficit to rise to 7% of GDP, or double the budgeted level, and states’ to 4.5-5% (against well under 3% in recent years) in FY21.

Moody’s has already warned of a possible rating downgrade if India’s fiscal metrics “weaken materially”. India’s debt-to-GDP ratio, according to Moody’s, rose to 72.3% in FY20, against 69.9% a year before.

Rookmaaker said Fitch would factor in the fiscal buffers that sovereigns had going into the crisis. “In India’s case, the fiscal buffers are small, but the external finances are resilient relative to many of its peers. India’s economy is relatively closed in nature and the RBI has strengthened its foreign exchange reserves in recent years.” Weakening financial sector could also weigh on rating action.

RBI has projected negative growth for FY21 without giving a specific estimate, while some private analysts have warned of real expansion slipping to as low as (-)5%. This will severely dent finances of the Centre and states.

According to an SBI Ecowrap report, as much as Rs 4.36 lakh crore could remain the uncovered revenue loss of the Centre even after its planned additional gross market borrowing of just over 2% of GDP in FY21. Interestingly, this is nearly equivalent to budgeted capital expenditure of the Centre. Similarly, the uncovered losses of states could be about Rs 3.2 lakh crore. “We expect states to at least strip their estimated budgeted capital expenditure for FY21 from Rs 8.8 lakh crore by 50%, if not more,” the report said.

Fitch had in December 2019 flagged “loose macroeconomic policy settings that cause a return of persistently high inflation and widening current-account deficits, which would increase the risk of external funding stress”. “This has really now become an issue for the medium term, in the current environment of weak demand and supply disruptions,” Rookmaaker said.

The recently-announced Rs 21-lakh-crore (over 10% of GDP) relief package is heavily loaded with supply-side measures, including the ones to ease liquidity flow, without enough stimulus to spur demand, they say. The actual fiscal impact of it is only about 1% of GDP.

Some economists, however, remain unperturbed by fears of rating action. Instead, they pitched for extending more demand-side stimulus at the earliest, going beyond the budgeted expenditure levels despite dwindling resources.

Noted economist and former chief statistician Pronab Sen asked why the policymaking apparatus is so worried about sovereign rating in times of a massive health and economic crisis and purportedly holding back stimulus. “Rating agencies are not stupid. They would much rather see growth being restored early than fiscal deficit being restricted at a reasonable level with negative GDP growth,” he said.

Sen said demand-side measures, like the income support (under the Garib Kalyan Package), should have been much larger and extended earlier. “But in any case, more measures to boost demand must be announced and implemented now, as lockdown restrictions are being eased,” he added.

For her part, finance minister Nirmala Sitharaman has indicated she will come out with more measures, although she hasn’t spelt out the nature of the likely steps.

As part of this Rs 1.7-lakh-crore relief package for the poor and the vulnerable, the government had on March 26 announced the transfer of Rs 500 a month to 20.4 crore women Jan Dhan account holders for three months. This will cost the government Rs 30,600 crore.

Commenting on fears of a massive spike in India’s debt levels, a sore point with rating agencies, M Govinda Rao, member of the Fourteenth Finance Commission, said: “Debt-to-GDP ratio will go up everywhere. So the appraisal of the relative performance of India vis-a-vis other countries will be crucial. A great lesson in macro-economy is that in times of great depression, governments need to borrow and spend. I don’t think rating agency are oblivious of this fact. Even if they downgrade, so what?”