#dnaEdit: Conflicting signals

One should not set too much in store by the judgments of credit rating agencies. Last week, Standard and Poor’s revised India’s outlook from negative to stable. Just as a downward revision need not be seen as a disaster, one need also not be excessively jubilant over the positive rating. It may be recalled that the credit rating agencies had given triple A rating to all the derivative papers which later were found to be sheer junk. Having said that, admittedly, the ratings have a bearing on decisions of investors in making investment decisions.  

Within four months of the Modi government coming to power, S&P has suddenly become aware of India’s stable political prospects. Moody’s, the other competing rating agency, had earlier viewed India positively. S&P  is also now upbeat about India having a manageable current account deficit.  In the rarefied world of analysts, people look at extensive data to assess whether their clients should put their money on debt. Their pronouncements are based on a judgment of market trends and anticipating them. Stakeholders look for insights which can lead the market. You get a ‘preview’ of the market. In this case at least, S&P is following the curve.  

Why has there been a turn-about in India’s rating ?
Political risks in  investment decision were resolved when the BJP got a comfortable majority in the Lok Sabha. One need not have waited so long to get at an assessment of the political risks of investing in India. The economic risks were identified even before that. India’s current account deficit had improved last year itself. The CAD itself was the biggest risk in 2012 when it crossed about $88 billion on the back of runaway gold, oil, coal and other imports. The prices since have come down. 

On the other hand, inflows have improved already. Foreign Institutional Investors (FIIs) have invested more in Indian equities and debt in the current year. Though they have withdrawn from equity markets substantial sums over the last few days. But debt instruments are appearing to be a favourite. Till August this year, FII debt investments stood at Rs1,02,473 crore compared with the net sales of close to Rs51,000 crore, in 2013. The overseas investors are keen to put their money in government securities and the earmarked amount for the year is nearly exhausted. 

Positive rating should encourage these trends. But will such a trend endure? 
Admittedly, we need money from overseas to supplement our resources for investment. However, buoyed up by positive ratings, larger inflow of overseas funds into Indian debt instruments can create a situation of greater volatility. It is a misconception that Greece or Spain, Portugal or Ireland are as robust economies as Germany, and that misconception helped build unsustainable deficits. Although we have imposed curbs on overseas investment in government debt, building up large debts with overseas investors is fraught with risks of instability. In times of strain, these funds will be taken out all at once and this will create volatility. Something that was witnessed in equity markets in the wake of US Fed’s announcement to wind down its Quantitative Easing programme in 2012. When the going is good, efforts should be doubled for corrections. It’s better to keep fiscal deficits low and reduce exposure to overseas funds. That will yield good results in the long term.