S&P warns India of potential long-term consequences

Giving its outlook for India, S&P has said that the country would have to make forward movement towards controlling inflation and fiscal deficit and cautioned that loose fiscal policies which impacted growth could downgrade the country?s sovereign rating. ?We do not see an immediate impact on India?s sovereign rating (BBB-/Stable) resulting from the lowering of the US sovereign rating to ?AA+?. However, potential longer-term consequences may point to negative factors,? S&P?s sovereign analyst Takahira Ogawa told FE in an e-mailed response.

Currently, India?s long-term rating stands at BBB-, the lowest investment grade, with a stable outlook.

Listing India among those Asia-Pacific countries that continue to bear the scars of the recent downturn in terms of reduction in fiscal capacities, the rating agency said a renewed slowdown (in the US and EU) would likely create a deeper and more prolonged impact on these countries than the last one. ?…the fiscal capacities of Japan, India, Malaysia, Taiwan, and New Zealand have shrunk relative to pre-2008 levels,? it said.

Although it is rather unclear as to how the present crisis would unfold, it has already alarmed the government and regulators. The Reserve Bank of India (RBI) is looking at revisiting its policy on foreign exchange investments while finance ministry is keen to ensure that the developments don?t impact markets badly and lead to loss of investors? confidence.

S&P has said that inflation remains India?s biggest challenge in the near term, as high inflation could push up credit costs and dampen the country?s economic growth trajectory. Although the pace of overall inflation has slowed down, food prices continue to spiral negating the trend.

Ballooning fiscal deficits also constrain the sovereign ratings on India, S&P has said, adding that continuing its fiscal consolidation policies into fiscal 2012 (ending March 31, 2012) would be a key challenge for the government, Ogawa said. ?We could raise the ratings on India if the government continues to reduce the public sector?s deficits materially. For example, future government initiatives to significantly reduce subsidies for fertilisers, foods, and fuels would be a positive factor in improving the expenditure structure of the budget and reducing the negative influence of potential external shocks on India?s fiscal position,? he said.

Strong commitment of the central and state governments to the medium-term fiscal consolidation plan set out by the 13th Finance Commission is key to India. ?Early implementation of the GST could help stabilise and potentially increase government revenues in the medium term and become a further positive factor for the sovereign ratings,: he said. ?Conversely, continued loose fiscal policy or policy setbacks on monetary, financial, and economic reform fronts that lower India?s medium-term growth prospects could result in a downgrade.? .

Meanwhile, S&P?s Indian arm Crisil also said that India would be impacted if global growth weakened further.

?The primary impact will be on the availability and cost of funding, both domestic and international,? Crisil managing director and CEO Roopa Kudva said. She added that an increase in risk aversion globally will reduce appetite for emerging market risk and could affect the ability of Indian companies to raise money externally. Access to equity markets too, is likely to be muted.

?The second impact will be on demand: export growth is likely to slow down and domestic private consumption, which has been strong so far, could moderate as consumers become more cautious?, Kudva added.

Volatility in exchange rates are also expected to increase.

However, the rating agency said, Indian corporates are likely to be cushioned by a primarily domestic-focused economy and strong balance sheets. ?While we will continue to see upgrades, we can expect a higher number of downgrades and higher defaults,? it said.