Bloomberg News

India’s Investment Grade Rating at Risk as S&P Cuts Outlook

April 25, 2012

India’s sovereign credit outlook was lowered to negative from stable by Standard & Poor’s, taking the nation a step closer to junk status and dealing a further blow to Prime Minister Manmohan Singh’s economic agenda.

“India’s investment and economic growth have slowed, and its current-account deficit has widened,” S&P said in a statement today, reaffirming its BBB- long-term India rating, the lowest investment grade. “We are revising the outlook on the long-term ratings on India to negative to reflect at least a one-in-three likelihood of a downgrade.”

Bonds fell, stocks declined and the rupee pared gains as S&P’s decision underscored rising concern that Asia’s third- largest economy will fail to stem a growth slowdown and widening budget and current-account deficits. Singh’s push to lure investment has been hurt by corruption scandals, inflation and political opposition to steps such as opening the retail industry to foreign companies.

“This just lengthens the shadow that has been cast over the India story,” said Vishnu Varathan, an economist at Mizuho Corporate Bank Ltd. in Singapore. “It raises the big fear of losing the investment grade rating, and what that means for financing costs and the efforts for fiscal consolidation.”

Bonds, Stocks and Rupee

The yield on the 8.79 percent note due November 2021 rose seven basis points, or 0.07 percentage point, to 8.64 percent as of 3:32 p.m. local time. The BSE India Sensitive Index declined 0.2 percent. The rupee pared earlier gains and was up 0.3 percent to 52.52 per dollar. It slumped 16 percent last year, the most in Asia.

S&P said diminishing growth prospects, a deterioration in trade performance or slow progress on fiscal reforms could lead to a ratings cut. It expects the government “to face headwind in implementing policy measures to improve its fiscal and macroeconomic parameters in the near future, given the current unfavorable political environment.”

There is no need to panic following S&P’s move, Finance Minister Pranab Mukherjee said in New Delhi today, adding reforms will be on track and that he is confident India’s economy will expand about 7 percent in the fiscal year through March 31, 2013.

In last month’s annual budget, Mukherjee estimated India’s fiscal deficit at 5.9 percent of gross domestic product in 2011- 2012, the widest in the so-called BRIC group of biggest emerging markets that also includes Brazil, Russia and China.

Record Borrowing

He proposed a cap on a subsidy program ranging from diesel to fertilizers and raised service and excise taxes, seeking to pare the gap to 5.1 percent of GDP this financial year. Funding the shortfall requires record borrowing of 5.69 trillion rupees ($108 billion) in 2012-2013, the government estimates.

Fitch Ratings and Moody’s Investors Service also grade India one step above so-called junk status. Fitch yesterday declined to comment on whether it plans to review or revise India’s rating anytime soon and reiterated its BBB- grade, with a stable outlook, on the nation’s long-term debt.

India’s economic expansion moderated to 6.1 percent in the quarter ended Dec. 31, the slowest pace in almost three years, as costlier credit hurt consumer spending and dented investment. The slowdown sapped tax receipts even as subsidies and a job- guarantee program for rural workers fanned spending.

Reserve Bank of India Governor Duvvuri Subbarao cut the benchmark interest rate by a greater-than-forecast half a percentage point on April 17, to 8 percent, seeking to bolster growth with the first reduction since 2009.

Lingering Price Pressures

At the same time, the Reserve Bank signaled that price pressures might limit room for further cuts. India’s wholesale prices rose 6.89 percent in March from a year earlier, giving it the fastest BRIC inflation.

Indian companies seeking credit overseas may face higher borrowing costs after S&P’s move, said Madan Sabnavis, chief economist at Credit Analysis & Research Ltd. in Mumbai. At the same time, the nation’s long-term growth outlook should help underpin investment flows, he said.

The Reserve Bank predicts Indian economic expansion of 7.3 percent in 2012-2013. The chance of a cut in India’s sovereign rating is low partly because its economy is set to rebound in the near term and given that the fiscal deficit is unlikely to worsen substantially, said Sonal Varma, an economist at Nomura Holdings Inc. in Mumbai.

S&P said it may change India’s outlook or credit ratings anytime in the next 24 months. The company said the ratings may stabilize if the government takes steps to “reduce structural fiscal deficits and to improve its investment climate.”

Challenging Period

Ratings changes aren’t necessarily accompanied by corresponding moves in bond prices. Instead of falling in value after S&P stripped the U.S. of the top AAA sovereign rating, Treasuries rallied and the government’s borrowing costs fell to record lows.

Singh’s administration is facing one of the most challenging periods since taking office in 2004. Among the setbacks was the suspension in December of plans to open India’s retail industry to foreign companies such as Wal-Mart Stores Inc.

Trade organizations have also said that businesses around the world are re-evaluating investments in India because of uncertainty over the nation’s tax laws following changes proposed in the March 16 budget.

Today’s action by S&P “is a negative move and further solidifies the macroeconomic risks India is facing,” said Rajeev Malik, senior economist at CLSA Asia-Pacific Markets in Singapore. “Coming from the most conservative of the rating agencies, it’s a wake-up call for the government to do something meaningful soon.”

To contact the reporter on this story: Kartik Goyal in New Delhi at kgoyal@bloomberg.net; Unni Krishnan at ukrishnan2@bloomberg.net

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net


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