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Apr 25, 2012, 08.08 PM | Source: CNBC-TV18

Govt's got 6 months to buck up on reforms: Economists

Finance Minister Pranab Mukherjee is sure to be an unhappy man after Standard & Poor's cut India's outlook to negative from stable.

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Govts got 6 months to buck up on reforms: Economists

Finance Minister Pranab Mukherjee is sure to be an unhappy man after Standard & Poor's cut India's outlook to negative from stable.

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Shubhada Rao (more)

Chief Economist, YES Bank |

Moneycontrol Bureau

Finance Minister Pranab Mukherjee is sure to be an unhappy man after Standard & Poor's cut India's outlook to negative from stable . Mukherjee just concluded his Washington trip trying to convince US corporates that there was no vacuum at the Centre and that there was no policy paralysis.

But the ratings agency has a different story to tell. In a press statement, the S&P cited India’s large fiscal deficit and expectations of only modest progress on reforms along with political constraints, battering stocks, bonds and the rupee as major headwinds.

No sooner had the news spread, the finance ministry activated its damage-control machinery saying the S&P has only waved a red flag and not downgraded India which will not impact the ability of corporates to borrow abroad. While this might soothe ruffled feathers of worried investors, experts point out that unless the government delivers on reforms, a downgrade is eminent.

Shubhada Rao of YES Bank says this is the government’s much needed wake-up call for them to stop slacking and take some actions as early as they can on particularly correcting the fiscal imbalances. She says the key concern that the rating agency has put for is on the reform initiative as well as on the preparedness of the government to go ahead with strong fiscal adjustments that are warranted.

The S&P’s outlook revision reflects their view of 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, it said in a note.

So, while this is not a downgrade right now but just a rating change, nonetheless fund inflows into India could also be impacted by this outlook change. Agam Gupta of Standard Chartered Bank points out that considering we are the lowest of the investment grade right now sentiment will definitely take a hit. “It will be a little bit more difficult for corporates to raise money. Even on the margins, if any fund decides to put money in India this will be another factor that they will have to take into account.”

Rao says India can breathe a little easy as the ratings agency is not yet looking at a possible downgrade for now. But she does add that the coming six months will be crucial for the government to buck up its pace of action on all domestic macros that rest in its backyard.

Abheek Barua of HDFC Bank finds the ratings cut will create more downward pressure on the rupee given that sentiment is terribly weak and that there could be a possible impact on the spreads on ECBs grade credit which will also affect flows if some banks have very mechanical rules for their exposures to India.

That said, Barua believes India doesn’t deserve a sub-investment credit rating. He says, “There is awareness among the three major rating agencies that given the fundamentals, however diminished they look at this stage, it is certainly not below investment grade and there is a long-term case for adjusting India’s rating upward.”

The initial reaction was a kneejerk reaction which is to be expected from the market but the market will in the end learn to digest this and things will stabilise. But that certainly adds to the downward momentum in the rupee at least in the near term, he adds.

One place where the Finance Ministry is correct is that relative to other markets, the problems that India faces are not that large, says Bhanu Baweja of UBS. If one looks at the degree of debt - the deleveraging that Europe and the US have to go through then, yes, India's long-term story is intact, but that's where the flattering comparison ends. We are now completely in the opposite situation where savings rates are falling and investments rates are falling too. There isn't much confidence in the industry.

He says its is become pretty obvious that the supply curve in India is fairly inelastic; there is a small increase in demand that led to an increase in inflation. Baweja says that for a country like India which has political compulsions there is going to be a cost for it and today’s S&P outlook reminder is just a case in point. “I do think that we will see more of this in the future. I think this will be followed by a decision on ratings itself,” he cautions.

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