India’s GDP growth forecast just got downgraded by Moody’s. Here’s why that matters

After an underwhelming 2017-18, where India’s economic growth was pegged at 6.6%, the current fiscal year was supposed to mark a recovery of sorts. The negative effects of demonetisation and the implementation GST were supposed to wear off, rural demand and private investment were set to increase and structural reforms to improve India’s financial sector and formalise the economy were supposed to kick in.

Keeping this in mind, in November 2017, Moody’s, a credit ratings agency, forecast a growth rate of 7.5% for India in 2018-19. At the time, it said it would downgrade its rating if “external vulnerabilities increased sharply”, or if the government’s fiscal strength or the health of the banking system declined further.

And this is exactly what happened.

As a part of it’s Global Macro Outlook report for 2018-19, Moody’s downgraded its estimate for India’s GDP growth to 7.3%. In fact, it lowered the growth estimates for a number of emerging markets such as Turkey and Argentina citing “rising borrowing costs” and “tighter conditions”.

It all starts with oil

Moody’s downgrade for India comes largely on the back of the rise in global oil prices, an “external vulnerability” which has significantly increased the government’s import bills, hurt the rupee and by effect, widened the government’s current account deficit. It has also increased inflation, which will affect consumption.

The government’s heavier financial burden will lead to lower spending on priority areas like infrastructure and the continued recapitalisation of India’s state-owned banks. The bad loan problem at India’s banks only seems to be getting worse, as total non-performing assets across the sector rose by a fifth to nearly ₹10.2 trillion at the end of March. As a result, the slowdown in corporate lending is bound to continue. And the government doesn’t really have the financial leeway to counter this with a stimulus programme.

What this ratings downgrade means

Macroeconomic forecasts and ratings from accredited ratings agencies like Moody’s and S&P function as important signposts for investors, institutional and private, and companies looking to enter a country. They help investors assess risk effectively and provide an objective assessment of a country’s prospects. This is especially important for emerging markets where statistics and forecasts by domestic agencies and government ministries can be biased or even, inaccurate.

A positive outlook can lead to greater investment and business confidence, while a negative rating or downgrade can cause panic among foreign investors, leading to an exodus of funds, and dissuade companies from expanding their operations and hiring more people.

This is actually what we’re already seeing in India. The net outflow of foreign funds from India is expected to have crossed ₹271.1 billion this month, the highest in 18 months. The ratings downgrade will dampen investor confidence in India further.

Moody’s did, however, leave India’s growth forecast for fiscal 2019 unchanged for the time being at 7.5%, indicating that India’s troubles could primarily be short-term in nature provided the government works to mitigate their impact and continue with its reforms.