The policy paralysis the government is often accused of has now been brought up by rating agency Standard & Poor’s. The agency on Wednesday revised the country’s long-term outlook to negative from stable and warned further deterioration of economic fundamentals posed the grim possibility of a rating downgrade.
According to the rating major, diminishing growth prospects, a worsening external situation and a lack of fiscal discipline are the prime reasons for the outlook revision. In addition, only modest progress is seen in key reform areas such as foreign direct investment in retail and insurance — both stalled by a lack of political consensus. The United Progressive Alliance government has been struggling to push key reforms due to opposition from within.
“The negative outlook signals at least a one-in-three likelihood of the downgrade of India’s sovereign ratings within the next 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,” Standard & Poor’s credit analyst Takahira Ogawa said.
The country’s GDP growth slowed to 6.1 per cent in the fourth quarter of 2011, the slowest pace since 2008, while the current account deficit for the first nine months is at 4.3 per cent of the GDP. That is way above the comfort level of the central bank. The fiscal deficit for 2011-12 was 5.9 per cent, higher than the estimated 4.6 per cent. For the current financial year, the deficit is seen at 5.1 per cent.
Commenting that a high fiscal deficit and a heavy debt burden remained the most significant constraints on India’s sovereign ratings, S&P said it expected only modest progress in fiscal and public sector reforms as the country got ready for the 2014 general elections.
The government downplayed the rating major’s warning by saying it was just a change in outlook, not rating, but admitted the warning was a ‘timely’ one. “There is no need for panic… The situation may be difficult, but we will be surely able to overcome (it),” Finance Minister Pranab Mukherjee said. The minister expects the economy to expand by at least seven per cent and is confident about meeting the fiscal deficit targets. (Click for graphs)
“Rating agencies are extremely cautious currently and India’s macroeconomic fundamentals are facing several headwinds. But, India is already at the lowest tier of the investment grade. Any further downgrade will lead to a non-investment grade rating for India, which the country does not deserve despite all the concerns,” said Siddhartha Sanyal, chief India economist, Barclays Capital.
According to market watchers, the only silver lining is the central bank has started reversing the interest rate cycle to boost the slowing economy. The Reserve Bank of India (RBI) had reduced the key policy rate or the repo rate by 50 basis points (bps) to eight per cent last week, as inflation declined. While cutting the rate, the central bank, however, said further scope for cuts was limited due to the resurgence of inflationary pressures.
Though the equity market dipped following on Wednesday’s announcement, it recovered losses as investors saw a low possibility of a rating downgrade.
“While this is incrementally negative for the Indian rupee and capital flows (portfolio and direct), we believe the rating remaining at investment grade contains the damage. Had a rating downgrade (to non-investment grade — junk) happened, it would have been far more negative, since it would have escalated funding costs for Indian firms abroad, and precluded some FIIs to access local debt and equity markets,” said Gautam Trivedi, managing director & head of equities, Religare Capital Markets.
The BSE Sensex, which opened at the 17,225 level on Wednesday, fell sharply after the S&P news hit the market between 11.30 am and noon. The Sensex touched a low of 17,019, only to recover later and close at 17,151. Similarly, the broader index, S&P CNX Nifty of the National Stock Exchange, closed at 5,202 after recovering from a low of 5,163.
Yields on government bonds jumped 7-10 bps post the S&P announcement. The yield on the 10-year benchmark government bond touched an intra-day high of 8.65 per cent before closing at 8.63 per cent, six bps higher than the close yesterday.
The rupee, which had risen to 52.47 levels against the dollar earlier in the day, fell to 52.74 levels as traders reacted to the news. It ended the day at 52.54 against the greenback on the back of dollar selling by foreign banks. It had closed at 52.68 a dollar yesterday.