Ratings agency Standard & Poor’s (S&P’s) on Wednesday cut India’s outlook to negative from stable, citing its large fiscal deficit and expectations of only modest progress on reforms given political constraints, battering stocks, bonds and the rupee.
The lowered outlook jeopardises India’s long-term rating of BBB-, which is the lowest investment grade rating.
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, S&P credit analyst Takahira Ogawa said in a note.
India’s 10-year bond yield rose 4 basis points to 8.63 percent, while the rupee weakened to 52.64 against the dollar from 52.48 before the action.
Stocks were also hit, with the main BSE index down 0.9 percent.
India’s fiscal deficit swelled to an expected 5.9 percent of GDP in the fiscal year that ended in March, far above the government’s 4.6 percent target.
Many economists believe New Delhi will have a tough time hitting its target of cutting the deficit in the current fiscal year to 5.1 percent of GDP, given a hefty subsidy burden and a weakened government that has failed to push through significant reforms.
Federal elections looming in 2014 are expected to limit the prospects for significant reforms that would improve the investment climate and India’s fiscal position.
The writing was on the wall given the country’s weakening debt profile and sluggish investment climate, said Radhika Rao, economist at Forecast Pte in Singapore.
With the coveted investment grade now at risk, one can only hope this acts as a wake-up call for the government, she said.
Moody’s has a Baa3 rating on India, while Fitch rates India BBB-. Both are also the minimum investment grade ratings. Moody’s in December issued a stable outlook for India.
COMMENTARY
RADHIKA RAO, ECONOMIST, FORECAST PTE, SINGAPORE
The writing was on the wall given the country’s weakening debt profile and sluggish investment climate. Focus yet again returns to the March budget disappointment as the government failed to undertake radical steps to cut subsidy spending, while FY12 deficit overshot estimates by a wide margin.
Lack of clarity on tax provisions, especially proposals to retrospectively tax investment deals, weighed on sentiments in the aftermath.
With the coveted investment grade now at risk, one can only hope this acts as a wake-up call for the government, with indications that administered fuel prices will be raised in Q2, a good starting point. Sustained improvement in the debt matrix will be necessary to avert an eventual downgrade.
DARIUSZ KOWALCZYK, ECONOMIST, CREDIT AGRICOLE CIB, HONG KONG
This is not surprising given weakening of fundamentals in the past quarters, but markets are likely to react negatively, with weakening of the rupee and bonds prices.
Domestically, I hear that exporters are not buying the INR as they see it weakening further, while importers have to sell. Also, foreign investment is being hampered by high FX volatility and reserve coverage of imports have deteriorated to multi-year lows, making the RBI more reluctant to intervene.
I expect regulatory measures soon and they could provide temporary respite to INR. Rupee is vulnerable due to high twin deficits (fiscal and current account) and inadequate policy response and should fall further in the short term.
SAUGATA BHATTACHARYA, ECONOMIST, AXIS BANK, MUMBAI
This (the S&P outlook downgrade) is a reinforcement of the various concerns that the government is trying to address. It is a negative signal, but I don’t think foreign fund inflows will be significantly affected unless there is an actual ratings downgrade.
JONATHAN CAVENAGH, FX STRATEGIST, WESTPAC, SINGAPORE
Net equity inflows into India stand at $9 billion year-to-date. This news combined with potential tax changes for foreign investors is a potentially potent mix for INR. Guess a re-visit to the 2011 USD/INR highs can’t be ruled out.
SURESH KUMAR RAMANATHAN, REGIONAL RATES AND FOREIGN EXCHANGE STRATEGIST, CIMB INVESTMENT BANK, KUALA LUMPUR
With the outlook negative, this is likely to put a strain on the currency and is on track to meet our Q2 target of 54.00 (to the dollar).
The OIS curve is tighter as rates inch higher particularly in the front end. This is made worse as liquidity is tight, with repo borrowings rising to 1.18 trillion rupees ($22.36 billion)above the comfort zone of RBI.
The curve is likely to steepen and we see the front end continuing to see much of the action as market prices in the risk premium of ratings outlook into negative via paying on the rates.
SHUBHADA RAO, CHIEF ECONOMIST, YES BANK, MUMBAI
It has had a quick sentiment impact. It may have a bit of adverse impact on capital inflows. And borrowing costs of corporates may get affected because of outlook downgrade, but difficult to say how much. We are not really looking at a downgrade possibility right away.
It wasn’t as a bolt from the blue. A lot rationale which was put forth by Standard & Poor’s for the negative outlook, was already known, like the worsening of the current account deficit, and slowing reforms, were practically known.
MARKET REACTION
* The 10-year bond yield rose 4 basis points to 8.63 per cent immediately after the action
* The rupee fell to 52.64 against the dollar from 52.48 beforehand
* The main BSE stock index fell 0.9 per cent
