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Moody’s downgrades India and takes rating action for 11 Indian banks - What does this really mean for you?

A rating downgrade for a country tends to affect its ability to attract investments. However, it is not the only parameter. The sovereign rating downgrade of India by Moody’s was not the only rating downgrade. And no this is not as disastrous as it looks.

Moody’s, the global financial rating agency, downgraded India from BAA2 to BAA3 in June. The decision was on the back of their perception of how the Indian economy is likely to do this year and going forward. They predict the GDP shrinking by 4 per cent.

This is driven by what they perceive to be slower than expected economic reforms, policy challenges, and economic challenges due to, and beyond, COVID-19. This downgrade is the first one since 1998 and is reflective of Moody’s negative outlook for India. Is this a serious and negative development, especially for investors? Let's find out. 

What does this mean?

A rating downgrade for a country tends to affect its ability to attract investments. However, it is not the only parameter. The sovereign rating downgrade of India by Moody’s was not the only rating downgrade. Countries such as France, Argentina, Mexico, South Africa also had a review of their ratings.

At present most countries have seen a review of their ratings thanks to the economic impact of COVID-19. In the case of India, Moody’s had already placed a negative view of India as early as November 2019 due to its assessment of the economic conditions of the time - mostly bank NPAs and stressed manufacturing. 

Therefore, the markets and experts were not really surprised by this. This could also suggest that India’s ability to attract foreign capital is unlikely to see significant change as a potential downgrade was factored in 2019 itself and in the months of the lockdown. India’s market still remains amongst the largest in the world and is the core reason why foreign capital comes to India. 

This also means that the larger growth story of India is intact considering the circumstances and present challenges. When companies/financial institutions decide to invest their money, they generally go looking for safety or opportunity, as one rarely gets both at the same time. As an emerging market, India represents amongst the best of opportunities and why we had the growth we had seen in the past decade or so.

While important, this downgrade is not a significant blow out of the blue for the capital markets and those who base their decisions on things like these.

At present most countries have seen a review of their ratings thanks to the economic impact of COVID-19. In the case of India, Moody’s had already placed a negative view of India as early as November 2019 due to its assessment of the economic conditions of the time - mostly bank NPAs and stressed manufacturing. 

The bank rating action

Moody’s Investor Services also decided to change the ratings or put them under review for 11 Indian banks. Most of these banks are public sector banks but it also includes names of Private sector stalwarts like HDFC Bank.

Banks which had their rating downgraded (negative):

SBI

HDFC Bank

EXIM Bank

Indusind Bank

Ratings under review for downgrade (possible negative):

Bank of Baroda

Bank of India

Union Bank of India

Canara Bank

Ratings affirmed (remained the same):

PNB

Central Bank of India

Indian overseas bank

What is a rating action?

Agencies like Moody’s constantly keep track of the baseline financials of companies and financial institutions. This is so investors, mostly institutional ones, can understand the risks associated with investing in these financial institutions. 

To this end, an organisation like Moody’s assigns ratings to these particular institutions based on underline factors like the credit quality of their borrowers, overall economic climate, regulatory environment, profitability, reserves and many other factors. A rating action is basically a change in the previously assigned rating or a review of that rating.

A rating action is not necessarily negative and can be upwards or even remain the same.

What caused this rating action?

Moody’s, as mentioned earlier, recently downgraded India’s sovereign rating due to the impact of the pandemic and the resultant lockdown. The disruption in economic activities due to it is likely to and has adversely affected most Indian businesses. This means India’s growth projections were not as Moody’s had anticipated earlier and thus it reviewed them and downgraded it’s previous more positive rating.

When you downgrade the sovereign rating of a country  - it can also mean the biggest banks will be affected. This is one of the key reasons why names like SBI and HDFC Bank are on the list as their deposits had similar ratings to the sovereign. 

Baseline Credit Assessment (BCA) - the driving factor behind the rating action

If you read the news stories around this, you will come across this term a lot. Baseline Credit Assessment is basically a check on the health of the bank in terms of the people and institutions that borrow from it. 

Any kind of economic downturn generally impacts this as institutions and companies that borrow from these banks come under pressure as their revenue streams are stressed and thus their ability to repay their borrowings also gets stressed.

In most of these rating actions, the baseline credit assessment has been impacted and thus for example in the case of HDFC bank specifically, the ratings for BCA went from BAA 2 to BAA 3. 

Does this mean Indian Banks are in trouble?

The truth is that the no financial institution is untouched from a crisis of the magnitude of COVID-19 and the unprecedented lockdowns that followed. Indians stopped working in many cases for two months, and a lot of our otherwise normal economic activities were shut. To assume that this won’t put pressure on every Indian firm and not just banks would be to deny the truth.

This rating action on the part of Moody’s is not as surprising if one considers the factors stated above. All of India and its economy is under pressure, but to say we are in trouble would be to underestimate the Indian economy. 

Enough jargons - what does this mean for you?

The rating action simply stated that Indian banking is under pressure because its customers (mostly institutional and who borrow from it) are under pressure. This does not mean too much for either the customers of the banks if you are one, or for investors in these banks, at least at this stage. 

Specifically for debt fund investors 

If you are a debt fund investor who has invested in debt funds with exposure to deposits from these banks, there is no reason to worry at this stage as pressured doesn’t mean bankrupt. The credit risk of these banks remains relatively stable for now and their sheer size should act as a shield.

Specifically for equity fund investors

If you are an equity investor invested in equity mutual funds with exposure to these banks, again there might or might not be short term fluctuations but the long term story is far from negative at least for the biggest banks. Considering how much of the economy is powered on the back of these banks, a positive outcome is more likely than a worst-case scenario.

Something like this was expected by the financial markets and might have already been factored in. The fall in indicators of manufacturing activities like the PMI already paints a difficult picture for the Indian economy. This year is one for riding out the storm and most of India Inc. knows this. What we all can rely on though is that India Inc has seen downturns before and has only come out stronger.

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