India will not get away unscathed from the impact of downgrading of US debt by Standard and Poor?s to AA+. But there?s not too much to worry about from a balance of payment?s perspective.
Country?s reserves are at comfortable levels. At around $320 billion, they adequately cover the short-term external debt with a residual maturity of one year of around $129 billion.
As Bank of America points out, ?One can safely assume that NRI deposits of $40.5 billion are unlikely to be withdrawn, given the 100-175 basis points rate differential over Libor?. Moreover, the near 50% of the $65 billion short term trade is typically accessed by oil companies, which are quasi-sovereign.
There could be some damage on the FCCB front for bonds that are due to be converted in the near term?a weak stock market may not allow conversion?but the quantum should not be significant.
The downgrade of US debt could mean a downgrade of debt for India too. What could hurt Indian corporates is the higher cost of borrowings in overseas markets since spreads would undoubtedly increase. However, credit off take has been sluggish in the first few months of 2011-12, which means borrowers will not be short of money.
At what cost they will get this money is of course another matter because interest rates remain high. Should crude oil prices and prices of other commodities ease due to a slowing global economy, now expected to grow at sub-2% this year, it would help tame inflation and put an end to monetary tightening. That would be a big boost for India?s companies. Nonetheless, anemic global growth, especially a double dip recession in the US, will have deleterious consequences on the Indian economy.
The first hit would probably be to the exports piece which now account for just under a fifth of GDP and, in the three months to June, have risen at 45% yoy.
India is of course better off than its peers, like China, whose exports are at 30% of GDP and Korea, which is even more vulnerable at 57%. While the rest of the world slows down, countries like China and India will continue to grow.
However, in India?s case, the government needs to convince industry that it means business and that it will speed up project clearances and other necessary legislation.
The June quarter numbers for capital goods companies confirm that capacity creation is tardy; order inflows at Larsen and Toubro for instance have risen just 3.6% yoy and 4.6% sequentially. Unless capital formation picks up, the economy could slow down further than anticipated which means slower corporate earnings.
So while Goldman Sachs may have upgraded India because it believes policy reform is gaining momentum, the government would need to ensure that the momentum
sustains.
After a correction of 19% from the all-time high of 21,005 that the Sensex hit last November, valuations are more reasonable at 14 times forward earnings. But that?s still a premium of about 18-20 % to the region and unless earnings grow as estimated, the premium could fast vanish.
Currently, FIIs own just under 15% of the Nifty and have no real reason to pull out money. But the government needs to ensure they?re going to be making enough of a return on it.