Why did Moody’s downgrade India’s sovereign ratings and why were the markets not perturbed?

On June 02, Moody’s downgraded India’s sovereign rating from Baa2 to Baa3 along with a shift to negative outlook. The trigger was COVID-19 but there have been structural issues too. GDP growth was 3.2% in Q4 and full year growth was just at 4.1%. Then there was the concern of negative growth in FY21. Moody’s also expressed concerns over fiscal deficit rising from 3.5% to over 6%. Then why did the bull rally continue on the Nifty and Sensex literally unfazed. Firstly, COVID-19 was a global problem and every economy is likely to show negative growth in 2020 and 2021. Secondly, Moody’s was the only rating agency to upgrade India’s ratings in 2018 and so the downgrade was more of a status quo reversal. The massive liquidity infusion also supported the rally.

The rating agency said the decision to downgrade has been taken in the context of the coronavirus pandemic, but was not driven by it. “Rather, the pandemic amplifies vulnerabilities in India's credit profile that were present and building prior to the shock, and which motivated the assignment of a negative outlook last year.” The Indian economy is seen contracting in FY21 due to the impact of the Covid-19 virus on the economy. Moody’s said it sees real GDP in India fall by 4 percent this financial year. It added that growth had been slowing even before the pandemic and may remain significantly below potential for the foreseeable future.