NEW DELHI: Global ratings agency Standard & Poor’s on Wednesday cut India’s sovereign credit outlook to negative from stable and warned of a one-in-three chance of a rating downgrade in the next couple of years. S&P cited persistent external risks to the economy, high fiscal deficit, heavy debt and a ‘weakened political setting’ that could slow reforms for the move.
The rating agency also slashed its outlook to negative for companies including Infosys, Wipro and TCS in the private sector, besides state-owned Exim Bank, IIFCL, IRFC, PFC, NTPC, NHPC and SAIL. All these companies have significant global presence.
The Opposition BJP, which blamed the policy paralysis at the Centre for the current state of affairs, said it was willing to work with the government for the passage of a couple of financial sector laws — the pension and insurance bills — in the current session of Parliament.
S&P’s India rating is “BBB-” at present, the lowest investment grade. The immediate lower grade is ‘BB+’, considered the highest speculative grade.
Finance minister Pranab Mukherjee said the S&P action was a “timely warning”, adding there was no need for panic as the government was determined to contain the fiscal deficit at the budgeted level of 5.1% of GDP in 2012-13. “The situation may be difficult, but we will surely be able to overcome it,” he said.
Economists, however, said the government should see this as a “wake-up call” and salvage the economy from the “precarious situation.” HDFC chairman Deepak Parekh did not mince words: “We have earned this revised outlook through our action and inaction. The worsening outlook is self-created and self-inflicted,” he said.
Besides a possible increase in overseas borrowing costs of corporate India, the revised outlook could also trigger a whole lot of negative developments for the economy, including a further dampening of business sentiments and drying up of investments. For the equity market, it could scare away foreign portfolio investors, already spooked by proposed tough anti-avoidance rules.
Yield on the benchmark 10-year government bond rose as much as 7 basis points at 8.64% on Wednesday, while the BSE Sensex fell 56 points to close at 17,019.24 points, in the backdrop of most Asian markets which rose.
Stating that the change in outlook reflected the “precarious situation” of the Indian economy, Delhi-based economist Mathew Joseph said the actual and psychological effects of the S&P action could result in further increase in bond yields which were already high. “Despite the recent 50 bps cut in policy rate by the RBI, banks seemed to resist all-round pressure to cut rates. I think with the S&P move, banks might not think of further steps towards lowering rates,” Joseph said.
Taking a slightly different view, JP Morgan’s Matt Hildebrandt said: “It (S&P action) is not going to have a major impact when the sovereign has no external debt.” Rajeev Malik, economist at CLSA, Singapore, said: “It’s clearly a negative development, and as to the extent of the impact, it depends on the global risk appetite. The constructive way to look at this is that the government should see this as a wake-up call and address these issues. We know all the problems, we know the solutions.”
The negative outlook signals at least a one-in-three likelihood of the downgrade of India’s sovereign ratings within 24 months. A downgrade is likely if the country’s economic growth prospects dim, its external position deteriorates, its political climate worsens or fiscal reforms slow, S&P credit analyst Takahira Ogawa said. However, the agency said the ratings could stabilise again if the government implements initiatives to reduce structural fiscal deficits and to improve its investment climate. Fiscal measures could include an increase in domestic prices and a more efficient use of fuel and fertiliser subsidies, or an early implementation of the goods and service tax, it said.
Moody’s has a Baa3 rating on India, while Fitch rates India BBB-. Both are also the minimum investment grade ratings. Moody’s in December issued a stable outlook for India. In October, Moody’s downgraded its rating of State Bank of India’s (SBI) financial strength by one notch to ‘D+’ on account of the lender’s low Tier-I capital ratio and deteriorating asset quality.
On Wednesday, Moody’s Analytics said India was growing but below its potential as politics is weighing on the economy and termed the national government as the “single biggest drag” on business activity. Senior economist Glenn Levine said: “India’s outlook is still underachieving. In all economies it is impossible to separate the economic from the political outlook, and that is particularly the case in India.”
The S&P action could spell deep trouble for the government, as it is slated to borrow the highest ever amount this fiscal for financing the deficit. In this year’s budget, the government significantly liberalised overseas borrowings rules for sectors like power and aviation, as this was considered essential to supplement domestic credit.
With the government appropriating nearly 70% of banking system’s annual deposits to meet its Rs 5.69 lakh crore borrowing requirement, the finance ministry went for tapping external loans to bridge any shortage in credit available to corporate sector. This strategy could now backfire with foreigners squeezing lending to India. At the same time, with no further possibility of reduction in interest rates by the RBI, government bonds may turn unattractive for FIIs, who have been recently trimming their debt holdings.
High crude oil prices and massive gold imports have pushed India’s current account deficit to 4% of GDP in 2011-12, the highest in eight years, up from 2.6% in 2010-11. Such levels of deficit created a balance of payment crisis in 1991. But the government and RBI have ruled out any such possibility now, given sufficient cushion provided by foreign exchange reserves and the country being the second-fastest growing economy in the world. S&P also said that India’s external position remains resilient despite the deterioration in the past two years.
Analysts were skeptical whether the government would be able to contain the fiscal deficit target and 7.6% growth projected for 2012-13. Asian Development Bank recently pegged India growth in 2012-13 at 7%. The RBI too has highlighted concerns on fiscal consolidation.
Market participants also doubt the government’s resolve to push through key reforms, including rationalisation of fuel and fertiliser subsidies. Due to lack of majority in Parliament for the UPA government, reforms in insurance, pension, banking and multi-brand retail have been hanging fire.
The finance minister, however, said the government will put economic reforms on track. “I do hope some of the legislation may be enacted during the latter part of the session and surely in the monsoon session,” Mukerhjee said.
“It is high time policymakers took reform measures and if such reforms don’t happen, there are chances of FII outflows,” SMC Global Securities research head Jagannadham Thunuguntla.
Total FII investment in April was negative at $145 million, against $12.4 billion in from January to April, 2012. In the same period last year, it was $2.2 billion, with January-April 2011 figure at $4.2 billion.
A senior finance ministry official said the outlook revision will not hurt capital flows into India or overseas borrowings by Indian companies. “The year 2011 saw downgrades of some 20 sovereigns; India’s competitive position is better than others,” the official said.
S&P last year downgraded its US rating to AA from AAA. The downgrade, however, resulted in investors putting in even more money in US bonds and equities.
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