S&P cuts India outlook, but markets shrug it off

Slowdown in reform and deteriorating economic indicators cause revision 

Rating agency S&P today revised the outlook on India’s long-term sovereign credit rating to ‘negative’ from ‘stable’ on account of slow fiscal progress and deteriorating economic indicators. It affirmed the 'BBB-' long-term and ‘A-3’ short-term unsolicited sovereign credit ratings. The transfer and convertibility assessment for India is unchanged at 'BBB+'.

"The outlook revision reflects our view of at least a one-in-three likelihood of a downgrade if the external position continues to deteriorate, growth prospects diminish, or progress on fiscal reforms remains slow in a weakened political setting," said Standard & Poor's credit analyst Takahira Ogawa.

India's favourable long-term growth prospects and high level of foreign exchange reserves support the ratings. On the other hand, India's large fiscal deficits and debt, as well as its lower middle-income economy, constrain the ratings.

"We expect India's real GDP per capita growth will likely remain moderately strong at 5.3% in the current fiscal year ending March 31, 2013, compared with about 6% on average over the prior 5 years, but down from 8% in the middle  of the last decade," Ogawa said. "India's favourable demography and the increasing middle-class population will undergird its medium-term growth prospects, which in turn will support the sovereign ratings," he added.  

India's external position remains resilient despite the deterioration in the past two years. The country's foreign currency reserves cover about 6 months of current account payments, down from 8 months in 2008 and 2009, said S&P.  

S&P noted that India’s net external liability position has risen to about 50% of current account receipts, but more than half is related to foreign direct investment and portfolio equity flows, which are less problematic than debt in most scenarios. Currency flexibility also offers a buffer against volatile external flows.

“The day the government takes action on oil subsidy the problem will be resolved,” says S Naren, CIO-Equity, ICICI Prudential Mutual Fund. 

S&P notes that high fiscal deficits and a heavy debt burden remain the most significant constraints on India’s sovereign ratings. It expects only modest progress in fiscal and public sector reforms, given the political cycle—with the next elections to be held by May 2014—and the current political gridlock. Such reforms include reducing fuel and fertilizer subsidies, introducing GST, and easing of restrictions on foreign ownership of various sectors such as banking, insurance, and retail sectors.

The negative outlook signals at least a one-in-three likelihood of the downgrade of India's sovereign ratings within the next 24 months. “A downgrade is likely if the country's economic growth prospects dim, its external position deteriorates, its political climate worsens, or fiscal reforms slow,” said Ogawa.

S&P said it could stabilise the rating if the government implements initiatives to reduce fiscal deficits and improves investments. Fiscal measures could include an increase in domestic prices and a more efficient use of fuel and fertilizer subsidies, or an early implementation of the goods and service tax.

Markets reacted in a knee-jerk fashion, but a correction set in later. The BSE closed down 56 points and NSE dipped 20.65 points.

Source: www.cafemutual.com

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