S&P downgrade—a wake-up call

[Shishir Asthana] 27 Apr 2012 11:45 AM

By Shishir Asthana, an independent investment banker  The growing frustration of the investor community with the policy inertia in India and all the wrong policy moves outlined in my last note was reflected in the recent outlook downgrade by the global rating agency Standard & Poor’s (S&P) yesterday. The rating is affirmed at “BBB-“ but S&P has put the outlook to “negative” from “stable” and warned of a possible downgrade if the government does not pull up its socks. As per a press release by the rating agency, the negative outlook signals at least a one-in-three likelihood of a downgrade of India’s sovereign ratings within the next 24 months. A possible downgrade of the rating from “BBB-“ would put India in the “junk” grade from the “investment” grade now. The implications would be drastic. There is around $40 billion foreign investment in Indian bonds, including around $15 billion in government bonds and the rest in corporate issuances. The cost of borrowing overseas would shoot up for the Indian corporates. The downgrade jolt could come at a time when the government is under severe financial strain and requires a good dose of foreign inflows to stabilise the rupee. What if another global crisis hits the world? India has limited scope to spend its way out this time around. The fiscal deficit is already close to 10% level including the deficit of the state governments and there is no elbow room for the government to increase spending in case a crisis hits the world again. This would mean that the economic growth could slip down much sharply this time around and the country will take many years to recover from the shock unlike in 2008-09. But there is a positive outcome of this whole episode. There is some solace for the government since the other global rating agencies like Moody’s have not downgraded the outlook. However, the growing criticism and veiled warning by S&P to take steps towards fiscal consolidation should force the government to take hard decisions now. The government cannot keep depending solely on the Reserve Bank of India and its monetary policy to do the job. Fiscal consolidation is necessary to support the rupee and also to lower the interest rates in the system which will be an important base to trigger a revival of investment by the private sector. The market has held up through the recent rough patch. But the patience of the investor community has reached the hilt. Unless the government makes the right moves the economy and the equity market are headed for troubled times. Disclaimer: The views expressed in this column are the views of the author and do not necessarily reflect the views of Sharekhan.