Moody's has acknowledged the measures the government has announced so far to boost the economy but has cautioned that these steps may not be enough to reverse the course of the slowdown.

International rating agency Moody’s has reminded the government and the central bank that the economic slowdown may last longer than what economists expected. The need for coordinated action between policymakers to arrest the slowdown is more relevant now. The agency has changed the outlook on Indian economy to ‘negative’ from ‘stable’ citing increasing risks to early economic recovery.

The rater has acknowledged the measures the government has announced so far to boost the economy but has cautioned that these steps may not be enough to reverse the course of the slowdown. Moreover, if the nominal Gross Domestic Product (GDP) growth does not return to high rates, the government will face very significant constraints in narrowing the general Budget deficit and preventing a rise in the debt burden, it said.

What does this action mean? A rating outlook downgrade is not the same as a rating downgrade. While Moody’s has lowered the outlook, it has affirmed the Baa2 foreign-currency and local currency long-term issuer ratings. Moody's also affirmed India's Baa2 local-currency senior unsecured rating and its P-2 other short-term local-currency rating. The change in the rating outlook is a reminder to the government that unless corrective steps are taken a rating action will follow.

Why a rater’s view is important? International investors typically take cues from the rating observations for investment decisions. The Indian economy has been losing growth momentum for successive quarters. In the April-June quarter, the GDP grew at a six-year low of 5 percent. Since then, the economic situation has deteriorated further.

The monthly industrial output data for subsequent months and core sector growth figures (which has a weightage of 40 percent in IIP) has shown weakness across major industries.

The growth in eight core sectors shrank by a massive 5.2 percent in September, after contracting 0.5 percent (later revised to 0.1 percent growth) in August and against an expansion of 4.3 percent in September 2018. Seven out of eight sectors contracted. Moody’s has observed that the government’s fiscal deficit calculations could be in jeopardy post the massive cut in corporate tax.

“With the recently announced corporate tax cuts and lower nominal GDP growth, Moody's now expects a Central government deficit of 3.7 percent of the GDP in the fiscal year ending March 2020 (fiscal 2019), marking a 0.4 percentage point slippage from its target despite significant one-off revenue from the special RBI dividend payment,” says Moody's.

Interestingly, this observation is not very different from what Economic Advisory Council to the Prime Minister (PMEAC) chairman Bibek Debroy said in his recent interview.

In his interview, the PMEAC chairman made it clear that the government is set to miss the fiscal deficit target this fiscal year. In Debroy’s own words, it is hard to say by how much it (deficit target) would be missed but there was no doubt it would be missed. The government is witnessing poor tax inflows (GST collection figures are indicative), while the pace of disinvestment is far from high targets. Moreover, the recent major corporate tax reduction announced by Finance Minister Nirmala Sitharaman would mean the government will have to sacrifice Rs 1.45 lakh crore hit on tax revenue.

GST collections are lagging

As this writer pointed out in an earlier piece, even after the government getting a windfall from the Reserve Bank of India (RBI) with Rs 1.76 lakh crore surplus transfer and a rumored Rs 30,000 crore dividend demand, it will be a tightrope walk for the government to hit the deficit target. But more than the fiscal deficit target, reviving demand in the economy should be the key focus at this juncture.

The government has taken a slew of measures to revive the economy. Of them, the biggest one so far has been the major cut in corporate tax rates. But, the problem with the Indian economy is that the current slowdown is on account of slowing demand. Unless consumer confidence improves and consumption picks up, it will be difficult to reverse the slowing trend of the economy.

Lower consumer confidence means lower spending by households on goods and services. Consumer confidence declined to a six-year low in September as sentiment on the overall economic conditions and employment availability expectations remained negative among households, according to a survey conducted by the RBI.

Consumer confidence trend has been assessed through the current situation index (CSI) and the future expectations index (FEI), both recorded a decline in September. Both CSI and FEI are compiled on the basis of net responses on the economic situation, income, spending, employment and the price level for the current period and a year ahead, respectively.

Moody’s has warned that potential GDP growth and employment generation will remain constrained unless reforms are advanced to directly reduce restrictions on the productivity of labour and land, stimulate private sector investment, and sustainably strengthen the financial sector. In other words, the government’s present approach of addressing sector-specific problems may not be enough to pull the economy out of the present slowdown trend. The economy requires a comprehensive reform roadmap mainly focusing on land/labour reforms and private investments.