A 4.4 per cent GDP growth in the first quarter of the current fiscal and the rupee quoting at 65.70 against the US dollar will undoubtedly raise downgrade fears on country’s sovereign rating among market participants.
Currently, India’s rating by all three global majors — Moody's, S&P and Fitch — is just a notch above junk ‘status’.
With the economy slipping, the potential of downgrading to junk rating looms large. Some of the key factors responsible for the country’s current precarious situation: weakening rupee, sluggish growth, debt-laden corporates, slowdown in the reform process and allegation of corruption at highest levels.
Already rating agencies have warned India of potential downgrade. After the Government passed the Food Security Bill, Moody’s said the measure was “credit negative” as it will weaken Government finances and deteriorate the macroeconomic situation.
S&P had made a perfect prognosis in February – the balance of risks behind its stable outlook on India’s rating may be shifting. “This shift is slightly toward the negative for reasons including: high inflation, a weak government fiscal position, and slower economic growth. These factors, in turn, have reduced investor confidence in the Indian rupee and triggered capital outflow, resulting in depreciation against major currencies.”
Macro headwinds
Despite the Government’s rhetoric, macro concerns linger. Most analysts believe that inflation is still at an elevated level.
As India relies heavily on commodity imports, the recent fall in rupee against the dollar does not auger well. A rally in the commodity markets, particularly crude oil, and weak rupee will give a double blow to an already strained economy. Current-account deficit, which indicates the excess of imports over exports, is widening at an alarming pace, the Government has targeted a CAD at 3.7 per cent of GDP, or $70 billion, in the current financial year.
Growth in GDP has tapered dramatically in the last three years. A 4.4 per cent growth in the first quarter of the current fiscal, which is the lowest in four years, is not good enough for a country like ours with a huge middle-class population.
Impact
Any further downgrades would widen bond yields dramatically across the board and funding costs would increase for debt-ridden corporates. This would put pressure on banks, which are already struggling with asset quality.
Besides, foreign investors will have to pull out their money, as they can keep their money only in investment-grade bonds. That could spark a broader sell-off, as the funding squeeze will put pressure on banks and corporates, which will result in a further downturn in the stock market.
Optimism
However, optimists still believe that India’s credit rating will not drop to junk in the near future as the Prime Minister and the Finance Minister have been saying India's fundamentals remain “too strong.”
Already key Government players are working on war footing to avoid such eventuality.
Finance Minister Chidambaram a few days ago met foreign investors to allay fears over India’s current economic situation and apprised them of steps taken to boost growth and stabilise the rupee, which touched a life-time low of 68.9 last week.
Economic Affairs Secretary Arvind Mayaram last week discussed the continuing rupee fall and the resultant macro-economic impact with the treasury heads of leading foreign banks such as Standard Chartered, HSBC, among others.
Besides meeting foreign players, the Government needs to initiate bold policy and reform measures by taking the people and political class on board to boost the flagging sentiment.
India Inc and investors are hopeful that this will happen soon. Will it?