Will Moody’s swing the bonds?

Updated on Oct 07, 2020 | By Author Sakshi Shekhawat

"While today's action is taken in the context of the coronavirus pandemic, it was not driven by the impact of the pandemic. Rather, the pandemic amplifies vulnerabilities in India's credit profile that were present and building prior to the shock, and which motivated the assignment of a negative outlook last year," it said.

Moody’s has maintained a negative outlook on India since November 2019 stating that if the nominal GDP growth does not return to high rates, it is expected that the government will face hardship in narrowing the general government budget deficit and to prevent a rise in the debt burden. 

India was already facing low levels of effective aggregate demand, which signaled at an economic slowdown. Measures were announced to counter this, but soon came the shock of a global pandemic - The COVID 19. This had put the already stressed economy in total shutdown for almost 50 days. As they stated, this amplified the risk of India’s growth, and in fact, with each successive nationwide lockdown, a downward revision on India’s projected growth continued. This ultimately leads Moody’s to cut the rating of the sovereign.


What does this mean?

This means that Moody’s expects a prolonged period of slow economic growth in the aftermath of this pandemic. The reforms in place and the COVID relief package announced by the Government, do not seem to be easing this pain, indicating limited policy effectiveness. 
 

Key factors

Firstly, the global economy is expected to contract, and India’s economy is also expected to contract in FY20-21. The COVID has notoriously impacted on stressed industries and businesses that were already battling low demand and has backed them in a corner. Several surveys from bodies like CII suggest that more than 30% of MSMEs could shut shop notwithstanding the aftermath of this compounding economic stress. This could lead to huge unemployment and a snowball effect.

Secondly, economic activities hit the lowest due to the prolonged nationwide lockdown, and hence, the GST collections of the Government have taken a huge hit. This will severely impact the revenues of the Government and widen the fiscal gap. This will leave the government no choice but to bridge the gap using more and more debt. 

The question here comes, how much of this debt is sustainable? And how much could this affect, if at all, the yields on new issuances and prices of the ones already floating?

Lastly, we need to remember that Indian corporates also borrow from overseas markets, the ECB route. Investors use sovereign credit ratings as a way to assess the riskiness of a particular country. This could adversely affect such borrowers as the interest cost on such borrowings could rise, making it difficult for them to raise funds when needed the most. 

Are government bonds not safe anymore?

However, some analysts have dismissed the decision of Moody’s downgrade. The easing of nationwide lockdown has also thrilled the stock markets which have ignored this rating change.

Also, unless there is a genuine risk of default, prices are affected more by interest rates, than minor upgrades or downgrades. It is rare for prices to fluctuate massively, say beyond 1-2% in response to rating changes.

It is also important to note here, that there may occur a minor fluctuation in the bond prices due to the downgrade in rating, however, since these are government securities, the principal and interest are guaranteed by the government. And when was the last time GOI defaulted on its debt obligation? 

On the contrary, I would take it a step further and say when the economic slowdown is anticipated, investment in equity markets and to corporates is much riskier. This makes G-Sec a much favorable to park funds in.

The margin of error

We can’t be completely dismissive of such ratings either. There is always a margin of error to be looked out for. 

Moody’s has maintained a negative outlook which could lead to a further downgrade if the situation doesn’t improve in the coming months. Foreign investors take such rating downgrades, especially consecutive ones while making their investment decision. 

 

A second consecutive downgrade, if it happens at all, within a period of say 18-24 months, would reflect that there is a higher risk of such lending, and thus, will have to be compensated for by offering higher and more attractive rates of return. This would lead to higher yields. It could also adversely affect the country’s intent to finance its deficits, especially from foreign investors. 

The confidence of foreign investors in our economy at large would decrease. 

Let’s hope it doesn’t come to that.

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