3 Reasons Why Moody’s Retains India’s Sovereign Rating To Baa3 With A Stable Outlook

‘Moody’s retains India’s Sovereign Rating;’ is a headline that greeted us this week. This is despite other agencies slashing their ratings.

What does this rating mean? Will the Baa3 rating impact India’s economic growth and should you know more about these ratings? The answer is a simple Yes.

Moody’s outlook rating reflects India’s economic environment and the reforms that have contributed to India’s growth and financial stability. Let us look at why Moody’s retained India’s Sovereign rating though it slashed India’s growth forecast to 7.7% last week.

What do Moody’s ratings measure?

Moody’s Investor Service rates fixed-income debt securities and assigns ratings based on the borrower’s creditworthiness via a standardized rating scale. This scale measures expected investor loss in case of a default. It also measures long-term foreign currency deposits, issuer, and senior unsecured debt ratings, and the bank’s baseline credit.

Investors often look at Moody’s, Fitch’s, or CRISIL’s ratings to gauge the risks associated with stock investment, bonds, and government securities.

History of India’s Sovereign Ratings

Moody’s had downgraded India’s sovereign rating from Baa2 to Baa3, with a negative outlook in November 2019. But after India’s economic growth and sustained bull run post-May 2020 Moody’s changed India’s rating from negative to stable in October 2021, two years after its downgrade in 2019. This year it has retained India’s Sovereign rating and EXIM’s long-term ratings to Baa3 with a stable outlook.

It has also upgraded EXIM Bank’s baseline credit assessment (BCA) and adjusted BCA from ba3 to ba2, which reflects an improvement in the bank’s standalone capital credit strength.

In June 2022, Fitch Ratings revised its outlook for India’s long-term foreign currency Issuer Default Rating (IDR) to ‘stable’ from ‘negative’ after a gap of two years but has retained the lowest investment grade of ‘BBB- for India’s sovereign rating for the last 16 years.

What Does A Baa3 Rating Mean?

A Baa3 rating is the lowest investment grade of Moody’s Long-term Corporate Obligation Ratings. These obligations are subject to moderate credit risk and considered medium grade with few speculative characteristics.

Reasons for Retaining India’s Sovereign Rating and Outlook

Moody’s said it retained the Baa3 rating with a stable outlook as India’s credit profile shows its strengths like the large, diversified economy with a potential for high growth, its strong external position, and a steady domestic financial base to support government debt.

It also believes the ongoing global challenges such as the Russia-Ukraine conflict, rising inflation, and tightened financial conditions globally will not affect India’s economic recovery from the pandemic. India has higher capital cushions and liquidity now. Also, the negative reactions between the economy and the financial policies are fading.

Though risks of high debt burden, low per capita income, weak debt affordability, and limited government effectiveness remain, analysts believe a positive economic environment will gradually reduce the government fiscal deficit in the next few years, avoiding a further decline of the sovereign credit profile.

Reasons For an Upgrade In EXIM, BCA, And Adjusted BCA Ratings

1. The material improvements in asset quality and capital and its expectations of an increase in profit in the next 12 -18 months as the high-credit cost burden reduced drove Moody’s to upgrade EXIM India’s BCA.
   
2. India’s gross non-performing loan (NPL) ratio declined from 8.75% at the end of March 2020 to 3.56% as of the end of March 2022 because of improved recovery, upgrades, and write-offs. The EXIM bank continues to have high provisions against the declining stock of gross NPLs with a net NPL ratio of 0% as of 31 March 2022 with a provision coverage ratio of 100%, which is higher than other rated Indian banks.
   
3. The Indian government infused capital in the last few years improving EXIM’s Capital. It reported a Capital Adequacy Ratio of 30.49% and a Tier 1 capital ratio of 28.58% as of 31 March 2022, higher than the 20.13% and 18.70%, respectively, as of 31 March 2020.
   
4. The ROA (Return on assets) rose to 0.5% as of the year ended March 2022 from 0.2% in the earlier quarter during the year, because as the asset quality improved the credit costs also declined in line with it.

EXIM’s final Baa3 rating is a two-notch jump from its previous rating as Moody believes it will get staunch support from the Indian government (Baa3 stable).

India’s Economic Scenario Now

Despite the ratings, FIIs have been flocking to the Indian stock market. In August, they turned Net Buyers with an inflow of more than Rs. 51,200 crores over the past year after months of pullback. In fact, they have been notable drivers of India’s financial market recovery. It means, that FIIs don’t specifically consider the rating when investing in Emerging Market Economies (EMEs) like India.

Will Moody’s upgrade India’s Sovereign rating?

Moody’s could upgrade India’s rating if its growth potential rose beyond expectations supported by effective economic and financial reforms that could augment private sector investments.

But the ratings could fall if the economic conditions become worse due to low growth in the medium term and a re-emergence of financial sector risks. Despite challenges, Moody’s retaining its Sovereign outlook is a positive sign for the economy.

The Q1 GDP may have fallen short of RBI’s forecast; however, India is one of the fastest-growing economies today. September 2022 saw India officially overtake the UK to become the fifth-largest economy in the world by market capitalization.

That just means there are enough opportunities for you to invest in the economy and create wealth. All you must do is take a careful look at all the aspects of the businesses, and decide on your time horizon before you invest. Remember, Long Term = Wealth Creation.