Sonal Varma, economist-India, Nomura and Siddhartha Sanyal, chief India cconomist, Barclays Capital discuss S&P revising India's long term rating to 'negative' from 'stable', on CNBC-TV18.
Sanyal also says that the currency market is quite under pressure and the current rating revision will add pressure to the currency market.
Varma says expecting bold or tough economic decisions may be difficult. There will continue to be decisions that will face least resistance see light of the day rather than bold decisions.
Below is the edited transcript of the discussion. Also watch the accompanying video.
Q: We know that the current account and fiscal deficit are worsening and reforms are stuck and these factors are a cause of worry. S&P has listed out fears that we already had, but do we still deserve a speculative grade?
Varma: Your point is correct. The outlook change clearly indicates that the economy is moving in the wrong direction and if we continue to go down this path then there is a risk of a downgrade which will be taken very negatively by investors. In 2007, India’s rating was upgraded. The economy is moving in a wrong direction and this is a warning bell to reverse that course.
Q: Is it fair to categorise India as one notch away from junk bond status?
Sanyal: In current situation you can't expect anything better than this. Despite all the problems we have, it is difficult to justify a situation where India goes below the investment rate or enters the junk rate once more. That is the reason we have some relief going ahead in the next few quarters, avoiding a downgrade in that sense.
Q: Do you believe that the government will now use a S&P review as a yard stick to take bold or tough decisions?
Varma: One can hope that the S&P review can be used as a measure to get coalition partners to agree. We may see a marginal hike in diesel prices in coming months. With elections due in May 2014 there is a short window available for reforms.
The government continues to face pressure from coalition partners. Expecting bold or tough economic decisions may be difficult. There will continue to be decisions that will face least resistance, see light of the day rather than any bold decisions.
Q: As Sonal pointed out, we will see those decisions which will be met with least amount of resistance, but that's not what India needs at this point in time. Should we now be prepared to face the downgrade?
Sanyal: Some things are not very clear. We do not belong to the camp which thinks that at least in this fiscal year there will be massive slippage in terms of fiscal deficit numbers.
There is a possibility of a 20-40 bps movement, but that will not shift the needle in a meaningful direction. I agree with Sonal on the point that, even if the government tries to push the coalition partners there may not be huge success on that front.
The government is required to come out with policy or measures in a coherent manner. There should not be a situation where a policy moves two steps forward and one step backward, which has happened many times at this juncture.
Q: What does this mean from investment and FIIs' point of view?
Varma: This is a negative signal that goes out to foreign investors. There will be some impact on overseas borrowing cost. Some overseas corporates will see some increase in the yields.
It is not about whether the government is able to meet this year’s fiscal deficit target. It’s about the way fiscal financials have deteriorated. Most of the worsening is structural in nature. Governance deficit led to an increase in current account deficit, higher inflation, lower potential growth and negative investment climate.
The message is clear that the economy is moving in the wrong direction. If we continue to move in the same direction then there will be implications for the economy.
Nervousness of FIIs and cautious to negative outlook on India because of worsening macro economic imbalances is something that has been reiterated by the rating agencies.
Q: What do the currency markets take away from this?
Sanyal: The currency market is quite under pressure and this will add another degree of pressure to that. Will we continue to see further sell-off in the equity market will be an important factor?
Possibly, in the near term there could be some activism from RBI in terms of intervention or policy measure which might try to counter balance. But, in terms of fundamentals the pressures are clearly building up further more.