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India downgrade may not be far off with out-of-whack fisc

Monday, 9 February 2009 - 3:42am IST | Place: Mumbai | Agency: dna

Is a rating downgrade nigh for India? Some analyst feel it may be, because of a rapidly deteriorating fiscal situation.

Is a rating downgrade nigh for India? Some analyst feel it may be, because of a rapidly deteriorating fiscal situation.

India currently is at the base of ‘investment grade’. Raters use their own nomenclature to say this. For instance, Standard & Poor’s and Fitch Ratings rate India ‘BBB’, while Moody’s rates Baa3. But AAA is the highest possible sovereign rating, which is still enjoyed by the US.

A downgrade would mean India becomes non-investment —- or junk —- grade. That would force many foreign funds to exit, because investor covenants bar them from investing in lowly-rated economies.

Interest costs will also soar for companies. Fiscal profligacy of the last one year means India’s fiscal deficit —the amount by which government’s expenditure exceeds revenue —- may reach a shocking 8% of GDP, according to estimates.

The Fiscal Responsibility and Budget Management Act, introduced in August 2003, requires the government to reduce fiscal deficit by 0.3% and revenue deficit by 0.5% every year.

It aimed to bring fiscal deficit down to 3% by March 31 this year, and completely wipe out revenue deficit.

“The local currency rating may be tantalisingly close to speculative grade,” Rahul Chokshi & Varda Pandey, analysts with Edelweiss Securities, said.

“The debt-GDP ratio and subsidy bills, which are amongst the criterion in rating rationale, have moved in a direction indicating a higher likelihood of a downgrade, which if realised will trigger an aggressive sell-off in the fixed income segment,” Chokshi and Pandey said in a note to clients last week.

India’s debt to GDP ratio, which indicates the country’s ability to repay debt, is abnormally high at nearly 90%.

Global agency Fitch has already revised the India’s long-term local currency to BBB Negative from BBB Stable last July.  

A local rating measures a country’s ability to finance local borrowings, while a foreign rating looks at the ability to service foreign loans.

Economists say that though India’s long-term foreign currency remains at investment grade with a stable outlook, pressure on foreign currency rating revision has also increased.

Latest government data show fiscal deficit has jumped to 3.5% of GDP, much higher than the 2.5% targeted by the government for the year.

Prime minister’s chief economic advisor Suresh Tendulkar has predicted a fiscal deficit of 7.5% by the end of March.

That’s not counting the so-called “off-balance sheet” items such as the Rs 60,000 crore farm-loan waiver and the Rs 85,000 crore fertiliser and oil bonds, which add up to nearly 2% of GDP.

Laveesh Bhandari economist at the New Delhi-based Indicus Analytics, said it is a Catch-22 situation for the government.

“If the government does not pump in money (and increase the fiscal deficit), growth will suffer. And if growth suffers, ratings may anyway have to take a hit,” he said.

Soumendra Dash, chief economist at rating agency CARE said the current economic downturn and strain on government budget has created a downward pressure on the currency outlook.

“Foreign lenders are subdued and averse. They are not confident. Foreign currency rating looks at capital inflow and outflow and whether the currency can withstand a downside risk,” he said.

But some economists say the poor global economic outlook may keep the knife off.
“The high fiscal gap is a global story and in this extraordinary situation rating agencies may not use the same yardstick that they normally do,” said Shubhada Rao, chief economist at Yes Bank.

Another economist at a rating agency who did not want to be named because he was not authorised to speak on the subject said he saw the Indian problem as temporary and hence did not expect a ratings downgrade immediately.

“This year the deficit situation has been bad but next year there should be some improvement. Also, besides deficit, agencies also look at the foreign debt, political situation, regulations. India is well placed on those counts,” he said.

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