Growth blues: Moody’s rating downgrade of India should turn government’s focus to economic growth

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Moody’s Investors Service this week downgraded India’s long-term foreign currency and local currency ratings a notch to Baa3 from Baa2. India’s rating remains investment grade but the outlook continues to be classified as negative. It’s been a sharp turnaround; Moody’s in November 2017 upgraded India based on expectations of economic reforms. The message is worrisome because the rating downgrade was not on account of Covid-19’s fallout. It was influenced by Moody’s assessment of the capability of India’s policymaking institutions and financial sector stress. The combined impact of these factors harms the fiscal situation.

The key takeaway from the downgrade is that the rating agency which was most optimistic about India earlier is now pessimistic about its ability to implement reforms. Consequently, it remains sceptical about recent reform announcements. All of this leads to questions about India’s long-term growth potential. Economic growth is crucial as it is the only channel through which India can confront its myriad challenges, including an increasing debt burden. India’s growth decelerated in the last three years and for the current year Moody’s joins a growing list of entities forecasting India’s first recession in 40 years.

Prime Minister Narendra Modi, in an address yesterday, spelt out his vision of a self-reliant India which envisages domestic industry catering to global value chains. It’s a laudable goal. But not one that can be achieved without deep reforms that make the economy competitive. Unless our competitiveness improves, it won’t be possible for India to be a crucial link in global supply chains. Modi could make a start by overhauling two key factor markets, land and labour. Reforming these markets shouldn’t be about temporarily suspending laws. Investors have a longer time horizon than three years. It’s about imparting flexibility, eliminating sclerotic bureaucracy and investing in human capital to move up value chains.

Ratings downgrades have costs for firms which raise capital abroad and even for government. Moody’s sovereign downgrade had a knock-on effect on ratings of four government controlled firms, including IRFC which raises money abroad to fund budgetary capital expenditure of railways. There’s no way out except to change every aspect which drags down India’s economic growth. Growth is the only way to alleviate mass poverty, increase India’s strategic heft and even win elections going forward. Those objectives can be achieved if the Modi government follows through on its reform announcements with concrete plans. Reforms need single-minded focus and political capital. There should be no more distractions.

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