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S&P threat spooks market

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Global credit rating agency Standard & Poor (S&P)’s alert on Monday on India sent a chill down the spine of stock market players. and see a in if S&P strips the country of its investment-grade status, which will vitiate the investment scenario.

Earlier, there was a belief in the market that the possibility of S&P downgrading India was as low as the likelihood of a nuclear war among Asian countries. However, this has now changed and S&P’s warning has started ringing alarm bells after the country’s economic growth slumped to a nine-year low of 5.3 per cent in the March quarter.

Key indices the Bombay Stock Exchange and the S&P CNX Nifty of National Stock Exchange gave up their gains in the last half an hour on Monday after S&P’s report, titled ‘Will India be the first Bric fallen angel?’, was circulated in the market. The Nifty fell below its 200-day moving average, a crucial support level. Both Nifty and Sensex closed the day after losing 0.3 per cent.

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The Sensex came off more than 250 points from its day’s high and finally closed 50.86 points down at 16,668.  This was despite a rally in most global markets after a $125 billion plan to rescue Spanish banks was approved by euro zone finance ministers.

“I can’t think what will be the consequences of S&P moving India to the category of junk-rated countries. There would be a huge crash and massive outflow of money. And the way things are going it seems S&P will act faster than the government does,” says Deven Choksey, managing director of the Mumbai-based Shares and Securities.

Choksey adds the government's inability to bring about any policy reforms for two years has hit the economy, and the rupee’s fall below 56 could mean outflow of money. "We are in problem for real. If the finance minister and the prime minister are talking about eight or nine per cent economic growth, they should say how will it be possible and also back it up with action. S&P's threats are no joke," said Choksey.

S&P revised India's rating outlook to negative from stable in April 2012 because of the country’s lower gross domestic product (GDP) growth prospects and the risk that its external liquidity and fiscal flexibility may erode. The 'BBB-' long-term sovereign credit rating on India is currently one notch above speculative grade.

Market's worry that big unwinding of participatory note (P-note) positions will be followed by S&P's action to cut rating. Although, P-note positions have declined sharply, foreign institutional investors still hold Rs 1.3 lakh crore through these off-shore derivative instruments and any chaos or major action like that of S&P is enough to trigger a panic. Indian markets lack depth to absorb such huge selling, and indices could see their worst, say analysts.

“S&P's concerns are genuine and are getting aggravated. The damage, in case of India getting a junk rating, could be incomparable,” said Sudip Bandopadhyay, chief executive officer of Destimoney Securities.

S&P's recent report states that the government's reaction to potentially slower growth and greater vulnerability to economic shocks could largely determine whether the country can maintain an investment-grade rating or become the first "fallen angel" among the Bric nations (which also comprise Brazil, Russia, and China).

"Setbacks or reversals in India's path toward a more liberal economy could hurt its long-term growth prospects and, therefore, its credit quality," said S&P's credit analyst Joydeep Mukherji. The negative outlook also reflects the risk that Indian authorities may be unable to react to economic shocks quickly and decisively enough to maintain the country's current creditworthiness, S&P said. "The combination of a weakening political context for further reform, along with economic deceleration, raises the risk that the government may take modest steps backward away from economic liberalisation in the event of unexpected economic shocks. Such potential backward steps could reverse India's liberalisation of the external sector and the financial sector," said Mukherji.

S&P had warned in August 2011 that India’s debt situation, among other Asian countries, was being closely monitored. This was a few days after it downgraded the US from AAA to AA+. Then, global stock investors Goldman Sachs and Bank of America Merrill Lynch had calmed Indian jitters.

While Goldman upgraded India to “marketweight" in August after keeping an “underweight" rating for over a year, Merrill had said in a note: “We would advise investors to ignore the inevitable chatter about India’s ‘external vulnerabilities’ as the world becomes a more volatile place. In our view, the Reserve Bank of India has sufficient fire power to fend off contagion as any other emerging market.” 

During the Lehman collapse, Merrill had always argued against the fashionable “vulnerability" rankings that simply added up current account deficits and forex reserves to short-term debt ratios. “The reality, surely, is far more complex. Not surprisingly, India (and Indonesia) that topped such lists weathered the Lehman crisis best (along with China). Why? Because India follows a very different paradigm of domestic demand-led growth than most other export-led Asian economies. The very domestic demand that widens the current account deficit also attracts its financing," Merill had said.

S&P's latest report examines the forecasts for economic growth, and the possible effects on business confidence and the government's commitment to economic reform.

The report also suggests that despite recent problems, the Indian economy remains in much better shape to withstand this period of heightened global uncertainty than it was in the early 1990s, when it suffered a balance-of-payments crisis.

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