With the recent downgrade of India’s rating from Baa2 to Baa3 tethered with a negative countenance, the incumbent economic impasse has exacerbated the pressures. In fact, gravity has acted with vigor on the ratings of several other economies. The revered largest economy was downgraded for the maiden time by S&P (Standard & Poor) from AAA to AA+. Indeed it’s a pity that Indian securities have been pushed to the lowest investment grade.
Comprehending the downgrade:
The downgrade has not been categorically associated with the pandemic outbreak, but a mélange of economic harbingers which proved bleak since 2019. Foremost has been the fiscal breach by GoI (Government of india) over successive years. In 2019-20, Ms Nirmala, who cracked the glass ceiling by turning out to be India’s maiden full-time women finance minister, fired distress rockets by invoking the ‘Escape Clause’ under Fiscal responsibility and Budget Management Act. Fiscal target breaches are supposed to be in years of exceptional circumstances, albeit India pressed its panic button much earlier. Charmless disinvestment achievements, contraction in GDP growth, truncated tax mop-ups made the GoI to elude its target fiscal deficit of 3.3%. With the onset of pandemic in the current fiscal, fiscal breach beyond projections, is a given. Some rating agencies anticipate India to touch 8% of GDP as its fiscal deficit for 2020-2021. The maiden quarter’s GDP (2020-21) has already witnessed a shrinkage up to 75% and its spillover is expected to extend till the third quarter, despite the phenomenal stimulus announced by the GoI. The extent to which the stimulus turns out to be of pragmatic sense, will decide the quantum of GDP shrinkage in the quarters to come. An analysis of prevailing scenario yields us the following conclusion – exorbitant liquidity with banks, but no takers for credit. In fact, predominant of the funds flushed in to the economy is returning back to the mint, as banks are depositing their surpluses at reverse – repo rate. Such a move also affects their interest margin of banks, since they have borrow at 4% (Repo) but deposit at 3.35% (reverse – repo). Moreover, bankers are not prepared to risk their war chest by lending to beleaguered entities. Albeit nothing can be done to the sum previously lent, in the least bankers out to be skeptical about extending further credit. On the contrary, depositors have poured in their savings, abundantly. The enhancement of deposit insurance to 5 lakh has instilled confidence among depositors, to further invest in their traditional safe-haven investment abode – ‘FDs’.
In November 2017, India scintillated with a rating upgrade to ‘Baa2’ bundled with ‘stable’ outlook. Moddy pointed that the structural reforms introduced in the country were expected to result in a ‘gradual but persistent improvement in economic, institutional and fiscal strength’. Passing of IBC (Insolvency and Bankruptcy Code), dovetailing of taxes through GST were the basis behind the partly panglossian stance of Moddy. Regrettably, implementation & time lags in the structural reforms introduced, have not augured well for India Inc since then.
Under IBC, about 30% of the cases admitted have retarded beyond the 270 days (resolution deadline under IBC). Expedited resolutions have remained an oasis, so far, defeating the pivotal purpose behind bringing in IBC. With the IBC abeyance in place and an ambiguous circular on ‘exempting covid related defaults permanently’, further recedes the efficacy of the code. Even the doors for a corporate debtor to file voluntary insolvency has been shut (since Section 10 of IBC is under abeyance). Blocking voluntary petitions would deepen the stress for corporates previously entangled in a vicious cycle of debt. GST implementation have hit the state treasuries of India. With the central mulling to share GST proceeds, states are left to survive with taxes on liquor & petrol. Its intriguing to note that liquor & petroleum have not been covered by GST ambit as they are currently being taxed at rates surpassing the maximum permissible ones under GST (18%).
After all it might take some years to settle the dust over these reforms. Replacement of Income tax with ‘Direct tax code’ is in the pipeline. The government has remarkably achieved in introducing structural reforms, but its implementation requires better attention.
India’s fiscal strength is a matter of grave concern. Despite whooping dividend pay outs from RBI & grappling with RBI for its revaluation reserves, India’ fiscal discipline is still a mayhem, or so the trend proves. With the negative outlook in place, the prospects for India Inc (a slang referring to the formal sector) approaching a foreign market for debt will turn out costlier & riskier. Dependence of foreign debts, bears an additional burden of currency depreciation. Remarkably, rupee has been one the worst performing currencies since 2019. The sole silver lining with India, is its forex reserves – which crossed half a trillion mark recently.
A better rating would make it less expensive for India Inc to borrow from foreign nations. Now that we are deemed more riskier with a rating downgrade, the government might predominantly depend on domestic sources (small savings & disinvestment) to heal its bleeding finances, unless the lender of last resort concedes for monetizing the deficit.