India’s Government Has Not Taken Steps To Control Deficit, Chance Of A Downgrade Persists: S&P

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By Naman Sanghvi:

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Original Article

Rating agency Standard and Poor’s (S&P) said there is a significant chance of cutting India’s credit rating in the future. “There is 1 in 3 likelihood of India downgrade in the next 24 months,” S&P’s Kimeng Tan told CNBC-TV18.

S&P roiled domestic markets in April when it cut India’s sovereign outlook to “negative”, putting at risk the country’s current rating of “BBB-“, the lowest investment-grade rating by the agency. India is the only Asia Pacific (APAC) nation to see negative outlook for the Eurozone instability, S&P pointed out.

Also, it feels Eurozone instability is still a risk to APAC sovereign ratings.

This comes even though the government had raised the price of heavily subsidised diesel last month to rein in its fiscal deficit and fight the threat of becoming the first of the big emerging economies to be downgraded to junk. The long-awaited decision follows intense pressure on Prime Minister Manmohan Singh to plug one of the biggest drains on the treasury. The UPA government is also grappling with a sluggish economy and a slump in investment.

S&P believes India downgrade likely if growth prospects dim, external position deteriorates, political climate worsens or fiscal reforms slow. “The implementation of announced reforms remains a key,” Tan said adding, the outlook may be revised to stable if reforms implemented, investment climate stabilises and structural fiscal gap issues are addressed.

Tan said the agency sees India FY13 current account deficit at 3.5% and the fiscal deficit at 6% of the GDP. “Expect the RBI to remain cautious in conducting the monetary policy,” he said.

Downplaying the possible downgrade, Prime Minister’s Economic Advisory Council chairman C Rangarajan said the S&P warning is “exaggerated”. However, he assured that actions are being taken to control fiscal deficit. He expects the WPI inflation to be around 7% in March

Explanation

Sovereign Rating refers to the outlook of a country’s (sovereign) ability to meet its financial obligations (both domestic and international). Sovereign Credit ratings give a very good picture to both a current investor and a future investor about the risk he faces with investing in a particular country

Companies like S&P, Moddy’s, Fitch etc. analyze the economic and political environment in a country and give ratings. Ratings range from AAA to D with intermediate levels like BBB+, BBB and BBB-. Fitch gave a BBB- & negative outlook, Moody’s a Baa3 & stable and S&P a BBB- & negative. For an entire list of rating’s country wise look up Wikipedia

When a country receives a negative rating it implies that the risk of investing in the country is higher- and is seen as a big roadblock for a country’s growth. A positive rating something that India enjoyed for quite some time before the downgrade implies that the country has a favourable investment and political climate, and it acts as a great boost for trade, markets, manufacturing and investment.

What are Junk Bonds?

India being downgraded further could prove disastrous, and as of now there is 1 in a 3 likelihood or a 33.33% chance of a downgrade in the next 24 months. A further downgrade would take India to BB and a ‘junk bond’ status. A junk bond is one which is ‘not worthy of investment’ and one which has a higher risk of default. Being assigned a junk status is one of the worst blows for a country as it sends out a signal to an investor that ‘this country might default on its obligations and might need a bailout- your money if you choose to invest here might not be safe’. To give you a idea of what the junk status does to an economy- On 27 April 2010, the Greek debt rating was decreased to “junk” status by S&P amidst fears of default by the Greek Government. Portugal followed with a downgrade in its rating to ‘junk’. The political turmoil and aversion of investors in both the countries give a good picture about the effect of a ‘junk status’ on a country.

The Eurozone crisis has affected economies around including China and India and is also an attributable reason.

One cannot simply blame the Eurozone, and one can argue that a far bigger reason has been the inward policies that are driving the Indian economy. Deficit or the amount the country owes depends on the a country’s policies. The current set of policies are not able to curb deficit and ‘in fact are allowing it to keep on rising’. With lack of political and economic reforms the situation will only deteriorate. From an When a country’s economic situation and policies are analyzed, a couple of important factors (Among others) that are looked into are

• Risk that the government itself might default on its obligations
• risk of need for governmental interference and intervention for external (foreign currency) obligations
• ability of the monetary structure to support banks and financial channels during a crisis and outlook on the local financial structure (like banks)

S&P said that India’ sovereign ratings outlook can be revised back to stable, if the government goes ahead with steps to reduce structural fiscal deficits, improve the investment climate, and increase growth prospects. Raising the price of diesel and capping the number of cylinders was a step towards decreasing the deficit. With opening up FDI in sectors like aviation, retail, insurance in principal allowing foreign companies to invest is yet another step in opening up the economy and improving its financial health. The Central Bank of India is under immense pressure and is monitoring the economy very closely. The recent reforms have been promising but not enough, and more reforms are needed.

A deficit of 6% is a big deal, and for India to return to a stable rating more fiscal reforms would be needed.

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