Rating downgrade a credible threat for India
(Rajiv Deep Bajaj is the Vice Chairman and Managing Director of Bajaj Capital Ltd. The views expressed in this column are his own and do not represent those of Reuters)
Indian stock markets have hardly gone anywhere since June, with the Nifty hovering in the 8-9 pct range. But the coming months may see a breakout of this range as volatility, as measured by the India VIX index, seems to be rebounding from four-year lows, after having fallen for three months in a row. A short-term break, out of the range, on the downside seems more probable.
Having said that, the recent collapse in stock prices of some companies, in which promoters had pledged a significant portion of their stakes, shows that the system is cutting down on leverage at the very grassroot level — the stock broker. When this happens, you know that ‘the bottom is nigh’.
The near-term outlook for Indian markets, however, also hinges on developments in the U.S. and Europe. U.S. equities seem to be at the height of their infatuation with QE3 and may be in for a rude jolt.
The recent leg of the rally in U.S. equities that started in June seems to be tiring out while Europe behaves like someone who promises a lot but yields nothing. As far as quantitative easing is concerned, the law of diminishing marginal returns has kicked in. Financial markets have turned less responsive every time the bond-buying bazooka is pulled out.
On the domestic front, the probability of mid-term polls is low simply due to the lack of a strong alternative, despite occasional rumblings by some regional parties claiming to build a ‘Third Front’. If at all a Third Front materialises and gains power, we know what to expect, going by our experience of the 1990s.
A sovereign rating downgrade remains a credible threat due to India’s dependence on foreign capital flows in the wake of a persistent current account deficit. India’s rating at BBB- is already at the lowest ‘investment grade’ level and a step away from being accorded junk status. S&P had cut India’s outlook to negative from stable in early April.
After the weak GDP numbers for the second quarter of this fiscal, released on August 31, S&P has reiterated its downgrade threat if the government fails to correct the fiscal situation. Presently, India, rated at BBB- by S&P, has been clubbed with countries like Azerbaijan, Croatia, Iceland, Latvia, Morocco and Uruguay, none of which come near it on grounds such as sheer economic size, growth potential, stability and diversity.
It is ironical that countries such as Ireland, Italy and Spain enjoy a better credit rating than India, despite being in a recession, having stressed sovereign balance sheets and being in the eye of the European sovereign debt crisis storm. Even countries like Bulgaria, Colombia, the Bahamas, Kazakhstan, Lithuania, Peru and Thailand have a better rating than India, a fact which hints at the fallacies of rating methodology.
Jim Rogers recently mentioned that he is underweight on India because of the high debt to GDP ratio, which according to him, has reached 90 pct. What does he have to say about Japan and Europe? Again ironically, he seems to be bullish on Japan.
Despite all ironies and the fallacies in the rating process, we must accept that we need to maintain our rating at the investment grade (BBB) level, simply because we need those foreign capital flows desperately. Almost all long-term foreign investors have a mandate to invest only in economies rated investment grade and above. A fall below BBB may stop them from investing in India. Indian policymakers know this, despite having rejected downgrade reports recently. No wonder the market is rife with rumours of an impending fuel price hike after the monsoon session of parliament.