Wednesday, June 13, 2012

S&P warns India on losing investment grade rating

The US based Credit Rating Agency Standard & Poor’s (S&P) recently warned India on its investment rating being downgraded to junk status.  India’s current rating is BBB-, the last rung among investment grade ratings. Among other BRIC countries, S&P has rated Russia and Brazil as BBB, and China AA-.
Such a harsh observation has been made by S&P due to worsening growth of the Indian economy in the recent months. Additionally, other indicators have also been worrisome. They include:
  • Significantly high levels of inflation, which led the RBI to follow a tight monetary policy for more than a year, eventually causing a slowdown in the industrial sector
  • Continuously sliding rates of industrial growth during the last three quarters
  • A continuous decline in the value of Rupee against the US Dollar which is making imports costlier
  • An ongoing declining trend in exports and widening trade deficit
  • Slowdown in FDI inflows
  • A general stagnation in the performance of companies’ stocks in the capital markets
  • Widening fiscal deficit
Reasons cited by S&P
S&P has been sharply critical of the policy stagnation in the country which has prevailed for almost two years now. It has found the following factors to be mainly responsible.
  • Policy delays due to coalition and populist pressures  
  • Continually increasing government expenses
  • Slowing down of exports and widening trade deficit
  • High subsidies and welfare schemes have led to fiscal deficit rising to 5.9% last fiscal
  • Doubts whether this year’s target of 5.1% could be achieved
  • Current account deficit is running at dangerous levels of 4% of GDP
  • Quarterly economic growth has fallen to a nine-year low.
Likely impact
There is already a general perception that the Indian economy is not doing well lately.
Global investors, rating companies and economists are now turning cautious about India as inertia in policymaking due to allegations of corruption and lack of leadership are diminishing hopes of any early economic recovery.
Now with the latest warning issued by the S&P, investor confidence is certainly going to be adversely affected. The Sensex fell 0.3% in the very next trading session after the S&P warning.

The response of the Government
The Union Ministry of Finance has expressed surprise at S&P’s pronouncements, pointing out that no substantive developments had occurred since April 25 when the rating agency reaffirmed its sovereign credit rating.
The Government of India has assured that it is continuing with its efforts to fix the economy. The Government is optimistic that there will be a turnaround in India’s growth prospects in the coming months. The main reasons behind this optimism are the following.
  • The RBI has reversed the interest rate cycle.
  • The mining sector growth has turned around.
  • Remarkable progress has been made on fuel linkage for coal-based power projects.
  • There is a turnaround in the quarterly investment growth rate.

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