India Risks Junk Status As Economy Faces 10% Contraction

The kind way to interpret India getting downgraded this week is that the news could’ve been worse.

Rather than cut India two notches to junk, Moody’s Investors Service just took one step to Baa2—the lowest investment grade. Yet this is no time for spin or delusion about where Asia’s No. 3 economy finds itself six years after Prime Minister Narendra Modi arrived in New Delhi to save the day.

After the events of 2013, it was hard not to argue India needed a dose of shock-therapy. At the time, it was among the emerging economies hardest hit by the “taper tantrum.” India made it onto Morgan Stanley’s “fragile five” list along with Brazil, Indonesia, South Africa and Turkey. Buzz in markets was that India might be the first BRIC nation—Brazil, Russia, India and China—to lose investment-grade standing.

In May 2014, voters turned to strongman Modi to shake things up. His 13-year stint running the western state of Gujarat turned Modi into a folk hero. Many Indians hoped he would unleash a similar deregulatory Big Bang on a rigid and uncompetitive national economy and strengthen New Delhi’s balance sheet.

Now, nearly six years to the day, it’s worth exploring why New Delhi is still on the verge of junk indignity.

The Covid-19 shock is, to be fair, slamming developing nations everywhere. India could make a plausible argument that the pandemic’s fingerprints are all over Moody’s warning that its financial outlook is “negative.” But then, as Moody’s stressed, India’s pre-existing conditions—particularly rising debt—are putting “persistent stress on parts of the financial system.”

That’s debt Modi and the Reserve Bank of India haven’t tackled with even a moderate level of urgency. Just as it’s best to fix a leaky roof when the sun is shining, it’s wise to curtail public debt before a global recession hits. Or a pandemic forcing governments to ramp up borrowing.

Even before the pandemic hit, India’s government debt-to-gross-domestic-product ratio was a high-among-emerging-economies 72%. It’s seen rising to 84% this year. Though New Delhi has long out borrowed peers, Moody’s warns India is about 30 percentage points above the median of Baa-range nations.

Can formal junk status really be far off? Though Modi boosters sell him as an amalgam of Ronald Reagan and Margaret Thatcher, he’s been far more enthusiastic about public stimulus than structural reforms. Bold moves to liberalize land, labor and tax laws have been few and far between.

Modi, I’d argue, has been more Shinzo Abe than Reagan or Thatcher. Like the Japanese prime minister, Modi talks a great game of deregulation. Just as Abe put a few modest reform wins on the scoreboard and moved on, Modi has since relied more on soaring rhetoric than retooling.

The emphasis has been on fiscal packages and central bank rate cuts. Modi, it’s worth noting, is on his third RBA governor. Last month, the latest one, Shaktikanta Das, slashed benchmark borrowing costs to 4.25%, the lowest since 2000.

Monetary liquidity bursts, though, are merely treating the symptoms of India’s troubles, not the underlying problems. Non-performing assets at the nation’s banks tripled between 2015 and 2019. That has rating agencies speculating banks will have to raise between $20 and $50 billion of capital over the next two years. This isn’t Modi’s fault, exactly, but it’s a reminder that New Delhi is letting imbalances fester.

Not surprisingly, Modi’s opponents are pouncing on debt complacency on Bharatiya Janata Party’s watch. As Congress leader Rahul Gandhi tweeted: “Moody's has rated Modi's handling of India's economy a step above junk. Lack of support to the poor and the MSME sector means the worst is yet to come.”

The MSME slight is one about which Modi’s team is sensitive. The reference here is to the micro, small and medium enterprises sector that Modi pledged to strengthen and expand. The idea was to create more jobs from the ground up, including a startup boom that increases India’s stable of tech “unicorns.”

Yet stimulus has taken precedence. The problem, of course, is that Indian growth is now grinding to a halt. India’s 3.1% growth from January to March are as good as things get as Covid-19 fallout upends global demand. Former finance secretary Subhash Chandra Garg expects the economy to contract by 10% this fiscal year, India’s first time in the red in more than 40 years.

Along with cratering global growth, Garg cites a “faulty” Covid-19 lockdown on the part of Modi’s government. The slowdown is sure to aggravate India’s underlying debt troubles. This darkening outlook, Moody’s says, won’t help a “negative” outlook that “reflects dominant, mutually-reinforcing, downside risks from deeper stresses in the economy.” These risks, though, would be a lot less troubling if Modi had used the last 2,200 days to get under the hood of a stalling economy.

If Modi wasn’t inclined to shake up vested interests when GDP was zooming along at 7% to 8%, it’s doubtful much will happen with growth in the 1% range. Cash also will become even scarcer for Modi’s $230 billion “Make in India” scheme to woo manufacturing business from China. That might be bearing more fruit if Modi had worked faster to make it a reality.

There’s every reason to think India can change the narrative Moody’s spelled out. But given the scope of its pre-existing conditions, and Modi’s tendency to treat symptoms more than underlying ailments, junk status could be closer than you think.