NEW DELHI: Stock markets ignoring rating changes is nothing new. Tuesday’s rally in domestic stocks was a redux of November 8, 2019, when the market had hit a record high after Moody’s changed India’s outlook to ‘negative’ from ‘stable’.
Why?
It is because rating agencies look through the rear-view mirror, but stock market looks ahead. By the time a rating status is cut, financial markets would have already priced that in and moved on.
Analysts said Moody’s rating downgrade may encourage other rating agencies to change India outlook to ‘negative’, but chances of them downgrading India rating to ‘junk’ are very low, they said.
At 11.30 am, domestic equity indices traded with a positive bias, logging gains for the fifth session running.
Moody’s later on Monday downgraded India’s sovereign rating by a notch to ‘Baa3’ from ‘Baa2’ for the first time in 22 years, while keeping its outlook ‘negative’.
Baa3 is the lowest investment grade. With this, Moody’s rating now matches that of Fitch and S&P, both of which already have BBB (minus) ratings on India, the lowest investment grade.
“Although the timing was a surprise, markets were likely anticipating a downgrade as Moody’s had moved India’s outlook to ‘negative’ back in November 2019,” said Nomura India.
“The incremental surprise, however, was Moody’s retaining its outlook at ‘negative’, citing downside risks to growth and the financial sector. Another downgrade would push India’s ratings to junk,” it said.
Two hours into Tuesday’s session, Sensex was up 235 points at 33,550 while Nifty traded near the 9,900 mark.
On November 8, 2019, BSE Sensex remained resilient for most of the session and even hit a record high of 40,749 despite Moody’s outlook cut, before witnessing some fag-end profit booking to end the session 330 points lower. FPIs were net buyers of equities to the tune of Rs 932 crore in that session.
On Tuesday, the reaction in bonds and currency markets was also muted. The 10-year bond yields were up for the sixth straight day at 6.06. In the currency market, the rupee depreciated 6 paise to 75.60 against the dollar.
Historically, across several countries, ratings actions have had little impact on interest rates and currencies beyond the immediate term, said Edelweiss Securities.
“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. More often than not, trends in growth, credit cycle, direction of monetary policy, Fed’s stance are far bigger drivers of bond yields and exchange rate than a rating action,” it noted.
There are two schools of thoughts; one feels governments worry too much about rating downgrades, which though keeps fiscal deficit under check but hampers policies that could otherwise be used to spur growth. The second group says ratings do reflect the economic challenges and one should not ignore them.
Risks to outlook stays
Kotak Institutional Equities said it is likely that S&P and Fitch will change India’s credit outlook to ‘negative’ to emphasise the deteriorating growth and credit profile of the economy.
“We, however, do not expect rating downgrades given the modest size of the fiscal stimulus (1 per cent of GDP) till now. Tax collections should also stabilise once the lockdown ends and economic activity begins to normalise. If India were to provide some consumption stimulus, it now has to be calibrated and targeted. This should be in conjunction with a fresh focus on enabling a restart of the investment cycle in the economy,” it said.
Moody’s argued that its rating action was not in reaction to the Covid-19 pandemic, but rather the vulnerabilities in India’s credit profile which were already present and building prior and got amplified because of the Covid-19 shock. It noted that effectiveness of the reform policies has been weak, which casts a shadow on the extent to which the current spate of reforms will be able to credibly restore medium-term growth, it said.
The rating agency said India’s public debt at 72 per cent of GDP in FY20, is 30 percentage points higher than the Baa median, and its interest burden is 3 times the median.
India not the only country to see downgrade
William Foster of Moody’s Investors Service says India is not alone in facing such a downgrade. Many other economies too have been downgraded, he said.
“There have been four areas in particular that we have identified in countries that before the pandemic were vulnerable. Countries that had negative outlooks going into this were already in a position where the trend was negative and that was well-forecast, well-telegraphed in advance,” Foster told ET NOW.
“We are being unnecessarily funky on that particular part. If you go back to the Taper Tantrums days of 2013, the macroeconomics were going hay wire, inflation was sky high, current account deficit was 4.5 per cent of GDP and we took a big hit under those circumstances. That is not the case today. Inflation is under control and our foreign exchange reserves are stable. We are in a solid position. We are more resilient than a vast majority of developing countries,” Swaminathan Aiyar, Consulting Editor at ET Now said in an interview last month.
Maintaining fisc counter-productive!
Edelweiss said any attempt to rein in the fiscal deficit amid slowing growth would only accentuate the dynamic of slowing growth and faltering tax revenues.
“Hence, reviving growth through fiscal/monetary activism is far more pressing from a debt sustainability standpoint than reining in fiscal deficit. And since external deficit is quite contained, India has the space to pursue the much-needed fiscal expansion,” it said.
