New DelhiMumbai: Global rating agency Standard and Poor’s (S&P) on Wednesday cut India’s rating outlook to negative from stable, citing the slow pace of fiscal consolidation, the worsening external sector situation, inflationary pressures and the sluggish pace of economic growth, nudging it closer to a “junk” rating.
Though S&P affirmed the lowest investment grade BBB- long-term sovereign credit rating, it said there is a possibility of a downgrade of India’s sovereign ratings in the next two years. A downgrade will result in India being rated in the “junk” investment category.
S&P’s actions could result in further depreciation of the local currency and make it difficult for companies to borrow funds from overseas markets, analysts and economists said. It will also add pressure on the government to take some difficult decisions to control the rising fiscal and current account deficits.
The government, struggling to overcome corruption scandals, recalcitrant coalition allies and an opposition buoyed by recent electoral victories, has found it close to impossible to push reforms aimed at reviving the economy. A recent cut in policy rates by the central bank may help shore up growth.
“We will take note. It is a timely warning,” said finance minister Pranab Mukherjee. He said, however, there was no reason to panic and that India will continue to work towards controlling its fiscal deficit and improving growth. “The reform process and necessary administrative decisions required to ensure that fiscal deficit is retained at projected level” will be taken, he said.
The change may have some effect on firms and inflows.
“In the short term, it will lead to a marginal increase in the overseas borrowing costs for companies,” said Shubhada Rao, chief economist at Yes Bank Ltd. “It may also affect capital flows into the country, which will exert further pressure on the balance of payments.”
Takahira Ogawa, credit analyst at S&P, said: “The outlook revision reflects our view of at least a one-in-three likelihood of a downgrade if the external position continues to deteriorate, growth prospects diminish, or progress on fiscal reforms remains slow in a weakened political setting.”
India is targeting a fiscal deficit of 5.1% of gross domestic product (GDP) for this fiscal year. But a higher subsidy bill and lower tax revenues resulted in its fiscal projections for 2011-12 going awry. As per revised estimates, India’s fiscal deficit is projected at 5.9% for 2011-12, higher than the 4.6% target. India’s current account deficit, too, has been widening on account of rising fuel prices and a large gold import bill, and is expected to be around 4% of GDP in 2011-12.
Long-term growth prospects and the high level of foreign exchange reserves support the ratings. On the other hand, India’s large fiscal deficit and heavy debt burden, as well as its lower middle-income economy constrain the ratings, the agency said.
In the current fiscal, S&P expects India’s GDP growth at 7%, the combined central and state fiscal deficit at 8% and current account deficit at 3.7%.
Following the downgrade, yields on bonds maturing in 2021 rose 4 basis points to 8.63%, before closing at 8.628% on Wednesday.
“The outlook downgrade doesn’t make much of a difference. The overseas sentiment is anyway driven by the liquidity scenario and credit market conditions,” said Jayesh Mehta, country treasurer at Bank of America-Merrill Lynch. “Now that the European crisis is brewing, that will have more impact on India rather than an outlook downgrade.”
Economists point out that the government has not announced any credible plan to curb expenditure, especially outgo on account of subsidies.
“This provides a trigger for the government to step up its reform process, particularly in subsidy management,” said Rao of Yes Bank. “Post the announcement, there was a knee-jerk reaction in the currency market, with the rupee falling around 20 paise.”
The rupee closed at 52.54 to the dollar against 52.68 on Tuesday, after hitting an intraday low of 52.75 after S&P cut the ratings outlook. The benchmark equity index, the Sensex, recouped losses following the outlook downgrade, ending 0.33% down at 17,151.29 points.
The revised outlook will “affect the international lending rates for India and the cost of borrowing from overseas would get expensive”, said Abhishek Goenka, chief executive of India Forex Advisors Pvt. Ltd. “The international funding for ECB (external commercial borrowing), FCCB (foreign currency convertible bonds) will also get affected, which will ultimately affect Indian GDP.”
Given the current political gridlock, S&P expects only modest progress in fiscal and public sector reforms, including the reduction of fuel and fertilizer subsidies, introduction of the goods and services tax, and easing of restrictions on foreign direct investment in various sectors such as banking, insurance and retail. “The ratings could stabilize again if the government implements initiatives to reduce structural fiscal deficits and to improve its investment climate,” S&P’s Ogawa said.
Though the interest rate cut by the Reserve Bank of India (RBI) could help in the growth momentum, the government needs to complement the central bank’s actions, he added.
With RBI having to balance between managing inflation and the government’s borrowing programme, the government needs to take steps to correct structural issues in inflation, Ogawa said.
Ratings agency Moody’s Corp. and Fitch Ratings Inc. have a Baa3 rating and BBB- rating, respectively, for India, both just one notch above non-investment grade. Moody’s issued a stable outlook for India in December.
S&P also lowered the outlook for a number of banks and public sector firms, including State Bank of India (SBI), Steel Authority of India Ltd, Indian Railway Finance Corp. Ltd and NTPC Ltd, to negative from stable. It did the same for India’s top technology firms as well— Infosys Ltd, Tata Consultancy Services Ltd and Wipro Ltd.
“This action is not warranted as the fundamentals of Indian economy are stronger compared with other countries in Europe. Hence, we do not think this is a right decision from S&P’s side,” said Brinda Jagirdar, head of economic research at SBI. “Our medium-term perspective is that India is quite well placed in terms of potential growth. Going forward, I don’t think this revision in outlook calls for any downgrade in the economy.”
By cutting rates, “RBI has taken the first step to address the issues of growth and inflation. Now it is the time for the government to take action by addressing supply-side concerns,” she said.
Nitin Jain, managing director and co-head (fixed income) at Nomura India, said the outlook change will not have any major impact on domestic or international markets. “The issues that S&P has highlighted are already known to the market and everything has been priced in. I won’t overplay the implications of this outlook downgrade,” he said.
remya.n@livemint.com
Dinesh Unnikrishnan, Joel Rebello and Aveek Datta in Mumbai, and PTI and Reuters contributed to this story.