~~Interview with Economist, Credit Suisse
Puneet Wadhwa / New Delhi May 03, 2012
What is your reaction to Standard & Poor’s downgrade of India’s long-term sovereign credit rating outlook? Is there a genuine reason to worry?
Standard & Poor’s has downgraded the long-term outlook on India’s sovereign credit rating to negative, while retaining the rating itself at BBB- (the lowest for investment grade). The other two main agencies, however, have a neutral outlook, both suggesting recently they have no intention of changing this at present (they too, rate the sovereign at just one notch above junk.)
Judging by the markets’ reactions, the announcement was an unpleasant surprise but not a particularly big one. In many ways, the move simply acknowledges the widespread frustration that many have been expressing in relation to the lack of government action on several fronts for some time.
What do you think prompted S&P to take such a step?
The absence of any clear structural reform announcements in the Union budget proposals in March could have been the final straw for the agency. In its statement, S&P has referred to the slowdown in capital spending and economic growth more generally, as well as the widening in current account deficit, as “resulting in a weaker medium-term credit outlook”.
Do you think India’s sovereign rating downgrade could become a reality?
Officially, the S&P move signals there is “at least a one-in-three likelihood of India’s sovereign rating being downgraded within the next two years”. We feel there is a reasonably small probability of a change, while, if it does occur, the move is unlikely to be imminent. Also, as S&P itself mentions, the country has favourable long-term growth prospects and a high level of foreign exchange reserves. The latter is enough to cover a reasonably comfortable six months of current account payments (down from eight months in 2008 and 2009, according to the rating agency).
Do you think the government will be able to kickstart the reform process and reverse this downgrade given the political compulsions or will they remain on the backburner as pointed out by the Prime Minister’s Chief Economic Advisor recently?
S&P expects the government to face headwinds in implementing policy measures to improve its fiscal and macroeconomic parameters in the near future given the current unfavourable political environment.
In our view, the government probably doesn’t need to do much to head off a move back to sub-investment grade status. The first key test is if, and by how much, it increases subsidised fuel prices. Although the current political scene makes an agreement on any vaguely contentious issue uncertain, the huge pressure on the finance minister from the Reserve Bank of India (RBI) and others means a rise remains more likely than not.
In our view, we will see diesel, kerosene and LPG prices hiked by the same amount and roughly at the same time as last year (June). This would have the benefit of leaving WPI energy price inflation unchanged.
A second test, which we are much less convinced the government will pass, is whether it is able to reach a compromise on the thorny issue of allowing foreign retailers to compete in the multi-brand space. Thirdly, many will be anxious to see the implementation of the GST and Direct Taxes Code plan. Both are thought likely to produce sizeable efficiency gains for the economy. We do expect these to come through but probably not until the start of the 2013-14 fiscal year.
All in all, it looks to us as though there is no reason to panic. The announcement / downgrade might even help spur the government into structural action, although unfortunately we suspect the impact is likely to be limited.
What is your growth forecast for India?
We have cut our 2012-13 and 2013-14 investment growth forecasts to three per cent (from 5.3 per cent) and nine per cent (from 11.2 per cent), respectively, while also shaving down our gross domestic product (GDP) growth projection for both years. We now expect real GDP to expand seven per cent this fiscal year (7.3 per cent previously) and eight per cent in the following year (from 8.2 per cent).
Do you expect a pick-up in capex spending over the next two years given the RBI could lower rates, going ahead?
It seems to us that the best chance of a strong pick-up in investment spending over the next couple of years stems from quick and aggressive interest rate cuts by RBI.
Bearing in mind the lags with which monetary policy works, we believe the time for rate action is now. Without it, there is a significant risk that capex spending will continue to stagnate for a long time, hampering the growth potential of the economy.