India’s sovereign credit rating was cut by a notch to the lowest investment grade with negative outlook by Moody’s Investors Service, which cited growing risks that Asia’s third-largest economy will face a prolonged period of slower growth amid rising debt and persistent stress in parts of the financial system.

The country’s credit rating was downgraded to Baa3 from Baa2, according to a statement. The outlook remained unchanged. “The decision to downgrade India’s ratings reflects Moody’s view that the country’s policymaking institutions will be challenged in enacting and implementing policies which effectively mitigate the risks of a sustained period of relatively low growth, significant further deterioration in the general government fiscal position and stress in the financial sector,” the ratings firm said on Monday.

India’s fiscal deficit in FY20 widened to 4.6% of GDP against the budgeted 3.8%.

Mint on 31 May reported that the country’s fiscal deficit in FY21 may breach the level of 6.4% of GDP, last seen in the aftermath of the global financial crisis in FY10.

India’s economic growth in the March quarter slowed to a 11-year low at 3.1%, partially reflecting the ongoing nationwide lockdown with fresh data suggesting a sharp contraction in GDP in the June quarter of FY21.

The rating agency said the negative outlook reflects dominant, mutually-reinforcing, downside risks from deeper stresses in the economy and financial system that could lead to a more severe and prolonged erosion in fiscal strength than Moody’s currently projects.

To be sure, Moody’s was always a notch above other agencies assessing India’s sovereign rating and, hence, had a greater risk of downgrade. Both Fitch Ratings and Standard & Poor’s have the lowest investment grade rating with stable outlook for India at present.

Fitch Ratings and Moody’s had in April warned a deterioration in fiscal outlook as a result of lower growth could put pressure on sovereign rating. Fitch said its assessment of India’s rating in such a scenario would be guided by its judgement of the country’s probable medium-term fiscal path in the post-crisis environment.

Moody’s said it had upgraded India’s ratings to Baa2, the second lowest investment grade, in November 2017 based on the expectation that effective implementation of key reforms would strengthen the sovereign’s credit profile through a gradual but persistent improvement in economic, institutional and fiscal strength.

“Since then, implementation of reforms has been relatively weak and has not resulted in material credit improvements, indicating limited policy effectiveness,” it said.

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