Why stock, bond markets shrugged off Moody's downgrade

Financial markets on Tuesday did not pay heed to Moody's first rating downgrade for India in 22 years. On stock exchanges, the BSE barometer Sensex gained nearly 1 per cent, the fifth straight session of rally. In the currency market, the rupee fell a tad 6 paise lower to 75.60 against the US dollar, which was not a big deal, given the last few sessions of continuous depreciation, while 10-year bond yield was ruling flat at 6.04.

Analysts say rating actions typically do not impact financial markets as Mr Market factors in changing economic circumstances real time on the basis of which rating agencies determine their ratings. That said, the market has already priced in the country's prolonged period of slower growth, rising debt, stress in the financial system, slow reform momentum and constrained policy effectiveness, key concerns that Moody's cited among reasons for the downgrade.

"Historically, across several countries, ratings actions have had muted impact on interest rates and currency beyond the immediate term. Even after Moody's upgrade in 2017, bond yields barely moved over the next few days. Perhaps, markets tend to adjust real-time to the evolving macroeconomic and debt dynamic. In fact, more often than not, trends in growth, credit cycle, direction of monetary policy, Fed's stance, etc are far bigger drivers of bond yields and exchange rate than a rating action," says brokerage Edelweiss Securities in a research note.

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Moody's has downgraded the country's credit rating to Baa3 from Baa, just above the junk grade, with a negative outlook. With this, its rating is now consistent with other ratings agencies such as Fitch and Standard and Poor's that rate India at the lowest investment grade 'BBB-'  but with a stable outlook.

Is junk grade in offing?

Sankar Chakraborti, CEO, Acuite Ratings & Research does believe that Moody's decision to downgrade India implies a possibility of further downgrade, but at the same, he highlights that rating agencies should take cognisance of India's resilience through past economic crises since the 1990s, its adequate foreign currency reserves and its institutional and regulatory framework that has strengthened over the past two decades. "While Moody's has expressed its doubt over the longer term growth potential and the policy effectiveness of the measures being taken by the government, we are of the view that the current economic scenario has set the stage for robust economic reforms which will help weather the current crisis and a reset to the earlier growth trajectory in another two-three years."

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As the country grapples with the coronavirus-induced slowdown, there are some silver-linings from low oil prices, substantial forex reserves to expected normal monsoon that should cushion the COVID-19 blow to some extent. BofA Securities cited three buffers that should support India to not fall below the investment grade. One, the RBI's high FX reserves that should protect rupee from any speculative attack. Second, the finance ministry will likely recapitalise public sector banks through non-fiscal levers such as issuing recapitalisation bonds and/or using the RBI's $127 billion revaluation reserves. Finally, a run of good harvests should cushion the COVID-19 shock. "After a bumper summer rabi harvest. We expect the winter kharif sowing to benefit from the Met's forecast of 102% of normal south-west monsoons," it says.

Fiscal measures - need of the hour

Moody's expects the country's GDP growth to contract by 4 per cent in FY21. The central bank RBI has already announced that it sees GDP growth to remain in the negative territory in FY21. Meanwhile, fiscal deficit has widened to 4.59 per cent of the GDP in FY20, overshooting the government's revised target of 3.8 per cent even as its Rs 20 lakh crore economic package to fight the coronavirus-led slowdown included just Rs 2-2.5 lakh crore of fiscal hit.

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Analysts continue to argue that more fiscal measures are needed to sail through the coronavirus-led slowdown. "While the Centre's fiscal deficit, at our 6.3 per cent of GDP FY21 forecast, will overshoot the long-run average by 180bp, this is surely justified with growth falling 900bp below potential. It is the fall in growth, due to the COVID-19 shock, that is leading to a higher fiscal deficit than vice versa," BofA Securities says.

Edelweiss Securities concurs that any attempt to rein in the fiscal deficit amid slowing growth would only accentuate the dynamic of slowing growth and faltering tax revenues. "Reviving growth through fiscal/monetary activism is far more pressing from a debt sustainability standpoint than reining in the fiscal deficit. And since India's external deficit is quite contained and disinflation/deflation is a bigger threat than inflation, India has the space to pursue the much-needed fiscal expansion," it says, highlighting that fiscal deficits are rising across the globe as one of the repercussions of COVID-19, not just in India.

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