Growth matters! Bonds sell-off as S&P says it could lower sovereign rating

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Updated: December 12, 2019 7:14:54 AM

The ratings agency explained that this year looks to be a particularly difficult one for the government's fiscal position, in view of sluggish revenue performance owing to the economic slowdown, as well as the expected impact of the powerful corporate tax cuts announced in September.

S&P also stated that India’s fiscal metrics, including its fiscal deficit, annual change in net general government indebtedness, and net government debt stock, are indeed weak.

Bonds sold off on Wednesday after S&P Global Ratings pointed out the possibility of downgrade of India’s sovereign rating, if “recovery does not materialise and it becomes clear that India’s structural growth has significantly deteriorated”.

The 10-year benchmark yield closed five basis points higher to hit a two-and-a-half-month high of 6.76%. The ratings agency said in a note, titled “Factoring Economic, Financial Risks Into Our India Sovereign Rating”, that India’s long-term economic growth performance forms an important pillar of the sovereign rating.

“Even in consideration of our relatively weaker growth expectations for this fiscal year – we are forecasting real GDP growth to decelerate to 5.1% – India’s long-term outperformance remains intact. Crucially, this assessment also incorporates our expectations for the economy to gradually recover over the next few years, with correspondingly higher growth. That said, if this recovery does not materialise, and it becomes clear that India’s structural growth has significantly deteriorated, we could lower the rating,” the report said.

S&P also stated that India’s fiscal metrics, including its fiscal deficit, annual change in net general government indebtedness, and net government debt stock, are indeed weak. The ratings agency explained that this year looks to be a particularly difficult one for the government’s fiscal position, in view of sluggish revenue performance owing to the economic slowdown, as well as the expected impact of the powerful corporate tax cuts announced in September. “If future developments suggest that deficits and the government’s net accumulation of debt will rise materially from their current elevated levels, possibly owing to an even more expansionary fiscal policy stance or worse-than-expected economic downturn, this could lead to downward pressure on the rating,” the report said.

Bond yields have been on the rise since the December monetary policy announcement when the central bank decided to keep the rates unchanged. This came as a complete surprise to the market that was unprepared for anything apart from a rate cut. It is noteworthy that bonds have lost all the gains made after the October monetary policy when the central bank had cut the repo by 25 basis points.

Dealers are indicating that they are now waiting for further clarity. “There is this news item where a ratings agency is indicating about a possible downgrade. The sell-off on Wednesday was based on that. Nobody wants to take chances when such kind of news is doing rounds. I think the market should take a breather at the current level although a lot will depend on what kind of sound-bytes will come forward,” a dealer indicated.

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