What would S&P's sovereign rating downgrade mean for India

Restricted FII inflows. a depreciating rupee, depleting foreign reserves and more

Although Standard & Poor's revision of India's long term outlook poses no real threat immediately, this is what we are setting ourselves for if the government fails to deliver definitive results in the next two years.

At this juncture, S&P's move is only a warning. But if we dont improve as per their expectations, and the growth prospects of the economy continue to be dim, the downgrade can come even before two years. There is no thumb rule which stipulates that a country has to be given 24 months to act. The government of India has to act fast on foreign direct investment in retail, GDP growth, fiscal deficit and current account deficit to avoid the downgrade.

India's downgrade from "stable" to "negative": What would it mean for existing and would-be investors?

The downgrade to BBB-, only one notch above "junk" status, indicates that the country is less efficient in paying off its debts. This would scare foreign investors and domestic investors from investing into government bonds and securities.

Jagdish Thakker, director, Vadodara Stock Exchange Limited, says: "Foreign investors look at sovereign rating of a country before investing, and the story for India is no different. Every fund abroad has (investment) allocations for various countries. For instance, the US might have allocated 25% of its total foreign investment plan for South East Asian countries, which includes Singapore, Malaysia and India, among other countires.

"So, of the 25%, India might be in a position to receive about 4-5%. If the downgrade comes about, this allocation would be restricted and would go to other 'better-rated' countires."

Foreign investors have been investing in the country since 2001, and so far they would have invested close to 3-lakh crore. "This amount will slowly be pulled out from the markets."

They would pull out money from the stock markets, using a method called "Algorithm" or "basket selling", which allows investors to put all their stocks in a basket and withdraw about 1 lakh shares just by a click, something that other softwares don't permit.

Another major threat for India would be the value of the currency.

The rupee has been depreciating against the dollar for the last few sessions and if the downgrade happens then "there is a possibility that the rupee can depreciate to 54-56 levels," he said.

This, in turn, would put a pressure on the balance of payments of the country as we import 70-80% of crude oil. If the rupee depreciates, we will have to pay more rupees to pay off the dollar-denominated imports. "Demand for dollar would also increase, which would make the rupee weaker."

We have about $270 billion foreign reserves in dollar terms with the Reserve Bank of India, which is enough to fund imports for the next six to eight months. "But if the downgrade happens, and the rupee depreciates, this reserve would start depleting fast."

Thakkar said: "In 1984, when Rajiv Gandhi took over as the Prime Minister after Indira Gandhi's assasination, we only had reserves to last for 15 days. We are not in such a bad situation currently, and the country should also remember that S&P is the same agency that did not downgrade USA's credit rating during  2008, nor did it downgrade Lehman Brothers."

He poined out that the threat is not as serious as projected currently, but the Central government should definitely take this as a note of warning. "The government has to act in order to avoid the domino effect of the downgrade. Else, the stock market would, what we call, 'Vertically crash'."