Ratings agency Moody's downgrades India's outlook from 'stable' to 'negative'

India's Prime Minister Narendra Modi

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Ratings agency Moody's downgraded its outlook on India's ratings Thursday from "stable" to "negative," citing increasing risks that the country's economic growth will remain "materially lower than in the past."

Moody's said the change partly reflected lower government and policy effectiveness in addressing "economic and institutional weaknesses" that led to a rise in the already high levels of the debt burden.

India is undergoing a significant slowdown. Its economic growth hit a six-year low in the April-to-June quarter, during which the economy grew 5% from a year ago. An ongoing crisis in the finance sector has hamstrung lending, impacting investments, while recent policy reforms have left small-and-medium businesses reeling. Moreover, the Indian economy is also struggling to create enough jobs for its workforce.

"While government measures to support the economy should help to reduce the depth and duration of India's growth slowdown, prolonged financial stress among rural households, weak job creation, and, more recently, a credit crunch among non-bank financial institutions (NBFIs), have increased the probability of a more entrenched slowdown," Moody's analysts said in a report.

In 2017, the ratings agency upgraded India's sovereign rating to Baa2 from Baa3, the lowest investment-grade rating. It was widely seen as an endorsement for Prime Minister Narendra Modi's reform agenda.

But in the Thursday report, Moody's said it "considers the prospects for effective implementation of such reforms to have diminished since its upgrade of India's sovereign rating in 2017."

"In the absence of such reforms, structural constraints on productivity and job creation, will weigh further on India's sovereign credit profile," Moody's said.

The latest report said prospects of further reforms — that could support investment and growth at high levels and broaden India's narrow tax base — have diminished.

Government data showed India's net tax collection in the six months ended Sept. 30 is lowest in the past five years, far below the government's budget target, local outlet Business Today reported earlier this month. Lower tax revenues could put a strain on the Indian government's fiscal deficit target of 3.3% of GDP as it aims to spend on some fiscal measures to stimulate the economy.

Radhika Rao, an economist at Singapore's DBS Group, told CNBC that the outlook change reflects concerns over growth and "anticipated fiscal slippage." She explained that if the government is able to demonstrate prudent spending and supports revenues by privatizing state assets along with expanding the tax base, then those worries would be allayed.

"Encouragingly, cyclical growth momentum is getting a hand from reduction in rates and surplus liquidity conditions, with impact likely to show in second half of the fiscal year," Rao said. India's fiscal year starts on April 1.

The Reserve Bank of India has cut rates by 135 basis points so far in 2019 to support growth and has signaled further easing.

Moody's affirmed India's other ratings and predicted the economic growth slowdown will be in part "long-lasting."

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