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India Downgraded – How Bad Is It?

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As Standard & Poor's downgrades India\'s credit outlook, EOS Intelligence takes a look at the causes and potential repercussions.

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India Downgraded – How Bad Is It?

  1. 1. Standard & Poor’s Downgrading of India’s Credit Outlook Reflects International Sentiments A chain of events in April has triggered global investors, economists, think-tanks and industry leaders to question the long-term viability of India’s growth story The IMF lowered Indias economic growth forecast to 6.9% for 2012, the lowest since 2009 Credit rating agency S&P downgraded India’s medium-term outlook from stable to negative (i.e. BBB-); the agency warned a further downgrade in the next 24 months, if the country’s fiscal situation was not put back on track Why the Downgrade? Widening Fiscal Deficit Deficit of GovernanceIndia’s fiscal deficit stood at 5.9% of GDP in the year ending The current government has been scathed by internal March 2012, significantly higher than the government’s conflicts, corruption scandals and an overall policy paralysis;target of 4.6%; the government’s populist employment and much needed reforms in the retail, aviation, telecom and welfare programs have been a huge burden on the coffer, banking sectors have been delayed resulting in gradual fall in resulting in government debt shooting to 70% of GDP investor and industry confidence“S&P in many respects is reflecting the international mood towards India and that is one where the near term outlookhas led many to become more concerned, more uncertain.” – Gerard Lyons, Chief Economist and Global Head ofResearch, Standard Chartered Bank (April 2012) In recent years, there have been few major policy announcements to boost India’s economic growth; though the country remains an attractive investment destination, investors seem to be gradually losing confidence given that much needed fiscal reforms are not being implemented 2
  2. 2. Lowering of Medium-term Outlook Is Likely to Impact Industrial and Service Sector Growth The medium-term impact of S&P’s downgrade is likely to be minimal, as this step by the credit rating agency is viewed as a warning to India’s policy makers; it would be, however, interesting to watch how potential foreign investors react to this outlook change and if there is a temporary decline in capital inflows Short-term impact of S&P’s decision, however, is already visible in the form of depreciating value of the Rupee, raising the cost of capital borrowing from overseas Manufacturing Banking & Financial Services Export-oriented manufacturing sector is likely to  Financial institutions, primarily the Indian benefit due to a weak rupee; however, India’s Central Bank, will have to contend with domestic industry, which relies significantly on raw inflationary environment amid government’s material imports, will witness a rise in operating costs, efforts to contain fiscal deficit leading to inflationary pressure  Volatile forex market may also pose challenges With the ongoing discussions on increasing oil prices, to the Reserve Bank of India and the already high cost of energy, manufacturers will take a hit on their margins Agriculture Service Sector  The agriculture sector will be affected if the  Weakening Rupee is likely to enhance short- government decides to curtail subsidies in order term revenues of most companies in the to manage fiscal deficit; an unlikely move by the service sector, as they largely earn from populist government in power foreign businesses  Hike in the diesel prices to limit the under-  However, companies funded through recoveries of the state-run oil companies would overseas capital may see erosion of margins also inflate the production costs in the agricultural-sectorQuantum of Impact of S&P Downgrade High Medium Low 3
  3. 3. Further Downgrading Would Severely Dent India’s Aspirations of Becoming a Global Superpower S&P may downgrade India’s ratings from BBB- (which is the lowest investment grade) to ‘junk’ status if the financial condition continues to deteriorate and the pace of financial reforms remains slow; there is one in a three chance that the rating agency would take such a step in the next two yearsConsidering the current state of economic and policy stalemate, S&P’s threat could become real; if that were to happen, it will trigger a chain of events that may severely impact the long term growth prospects of IndiaAny move by S&P or othercredit rating agencies tofurther downgrade India’s AA-ratings would be a result(rather than a cause) ofthe Indian government’sinability to pull theeconomy back on track BB+ The cost of capital would become significantly high making it difficult for services, housing and B+ infrastructure sectors to Foreign investors may take raise fresh capital their money to competing This would further retard Asian countries with better economic growth and has A+ credit rating and investment- a potential to turn in to a friendly fiscal policies vicious cycle 4
  4. 4. About EOS IntelligenceEOS Intelligence is a professional services firm that delivers bespoke research solutions targeted at corporateplanners and decision makers, and institutional investors.Our knowledge resources, spread across sectors such as automotive, consumer goods, energy and healthcareenable us to support a wide range of research and intelligence needs, spanning strategy assessments, supply chainrationalization and investment analyses.We work closely with corporate and consulting firms, and provide them with customised business research andintelligence solutions that significantly contribute to their strategic and functional decision making.If you would like to know more about our research solutions, please visit our website www.eos-intelligence.com. 2012 © EOS Intelligence. All Rights Reserved.

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