India's Deficit Threatens 'Junk' Rating

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As elections approach, the government is unlikely to make any further major decisions, although that could change if the economy deteriorates rapidly. A new government won't be ready until mid-June, giving both economists and politicians time to see if these stimulus packages can do their job.

Investors Backing Out

Recent indicators don't bode well. Just last week, foreign institutional investors (FIIs), who had buoyed India's stock markets from 2003 to early 2008 with billions of dollars of fund money, sold about $380 million more in Indian shares than they bought, according to data maintained by the Indian stock exchange regulator. Indeed, in the financial quarter ended in December, FIIs sold $3.8 billion worth of Indian stock, dragging their share of the Indian stock market down to 2003 levels, at about 15.5%, according to a Citigroup (C) report.

That is putting pressure on the Indian rupee. It fell 24% in 2008 and is down another 2.5% this year against the dollar, as the Indian government sold foreign exchange to increase liquidity in the market. The rupee's weakness hasn't helped exports that much; India's largest export industry, textiles, has lost orders to Vietnam and Bangladesh, and the country has fallen off the list of the top five garment exporters globally. Meanwhile, the impact of last November's terrorist attacks in Mumbai and the January scandal at Satyam (SAY), once India's fourth-largest IT company, have tainted India's image as a destination for the world's investment. "Without doubt, Brand India has taken a hit," said Nandan Nilekani, the co-chairman of the board of directors for Infosys (INFY), India's second-largest IT company by revenues, speaking to foreign media at a conference on Feb. 19. "And it will take a lot of measures to improve that image."

On the other hand, India's banks, whose credit outlooks were also revised by S&P to match the country's, are relatively well capitalized and for now appear eager to buy government bonds at a time when other predictable investments are scarce. India will hold a $2.4 billion debt auction on Mar. 4, and previous auctions have gone well. In fact, much of India's recent debt has been raised domestically, says Ogawa. The country's foreign debt is more than manageable: India currently holds more than three times the foreign exchange it needs to meet short-term debt requirements. This year the Indian government will borrow a record $72 billion from capital markets, both local and foreign, according to a projection by the Controller General of Accounts for India.

For now, though, Moody's Mitra expects to wait and see if the stimulus plans work before taking any action on a possible downgrade. "Some of these stimulus packages could be quite effective," he says, even though he is concerned that some of the more publicly visible plans have been announced with an eye to the upcoming elections. "Where does stimulus end and where does populism begin is in the eye of the beholder," says Mitra.

Srivastava reports for BusinessWeek from New Delhi.