India’s tally of COVID-19 cases has increased at an alarming pace. Given India’s limited health infrastructure, this has had a devasting impact on health outcomes across India. The pandemic’s second wave has cast a shadow on the ongoing recovery.
DBRS Morningstar downgraded India’s Long-Term Foreign and Local Currency – Issuer Ratings to BBB (low) from BBB. And India’s Short-Term Foreign and Local Currency – Issuer Ratings to R-2 (middle) from R-2 (high).
The downgrade reflects the material deterioration in India’s public finances as a result of the global health and economic crisis. The country arrived to the crisis with a comparatively weaker fiscal position than most of its BBB-rated peers and a slowing economy. Although a recovery is underway, the economic impact of the virus has been severe.
The government remains committed to a sound macroeconomic policy framework, but the spread of the novel Coronavirus Disease (COVID-19) compounds India’s existing credit challenges, including structural impediments to faster productivity growth, elevated government debt levels, and asset quality concerns within the financial sector.
The downgrade reflects the deterioration in the ‘Debt and Liquidity’, and ‘Economic Structure and Performance’ building block assessments.
The impact of the pandemic will add to an already high stock of public debt. The IMF projects that general government debt will increase from 73.9% of GDP in FY20 to 89.3% of GDP in FY21. Higher debt is translating into higher interest costs, despite lower rates. DBRS Morningstar expects only a gradual repair to public finances in the coming years.
Having said that…
The trend on all ratings has been changed to Stable from Negative.
This reflects DBRS Morningstar’s expectation that the policy response will preserve macroeconomic stability and support the economic recovery once the pandemic is contained.
While direct fiscal response was limited, the regulatory and monetary policy measures have eased domestic financial conditions as reflected in lower interest rates and compressed spreads across the spectrum.
Exchange rate flexibility, a relatively low level of external debt, and high forex reserves have also reduced external vulnerabilities.
The implementation of structural reforms announced as part of the COVID-19 relief package and budget also bodes well for India’s medium-term growth prospects.
The economic impact of the second wave is likely to be less severe.
Lockdowns are more localized, households and businesses have learnt to adapt to and work around the virus, and the vaccine program is underway. Thus, once the pandemic is contained and restrictions are eased, pent-up demand and investment-enhancing and growth-supportive reform measures taken by the government will help the upturn.
Following a contraction of 8.0% in FY21 (April 2020-March 2021), official estimates (RBI) peg growth at 10.5% in FY22. Private sector estimates, though slightly higher, are seeing a slight moderation following the recent surge of COVID-19 infections.
The outlook remains uncertain as the pace of the economic recovery will depend in large part on the evolution of the virus, when the second wave peaks, and the pace of vaccine distribution.
India’s medium-term growth prospects remain strong.
- While the pandemic has had severe near-term effects, India’s favourable demographics, relatively high savings, and potential catch-up in technological know-how suggest that India’s medium-term growth prospects remain strong.
- Over the last few years the government has been tackling some of the structural issues to improve the investment climate. This includes simplifying business regulation, enacting the Insolvency and Bankruptcy Code, easing restrictions on foreign direct investment, introducing the Goods & Services Tax and reducing corporate tax rates. In addition, the Jan Dhan–Aadhar– Mobile (JAM) trinity which links bank accounts, Aadhar IDs and mobile numbers has increased financial inclusion.
- In the World Bank’s Ease of Doing Business report, India’s international ranking improved from 142nd in 2014 to 63rd in 2019 among 190 countries.
- Net foreign direct investment flows have also increased sharply rising to $43 billion in FY20 compared to an average of $32 billion during FY15- FY19.
- Measures announced as part of the COVID-19 relief package – mining, FDI, production linked incentive schemes and labour reforms – and recent budgetary announcements regarding privatization, asset monetization, creation of a bad bank are credit positive if implemented efficiently.
- The economy has demonstrated a high degree of resilience in recent years, due in large part to a well-regulated financial system, a credible inflation-targeting regime, and a flexible exchange rate.
