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US Ratings Downgrade: Blessing in Disguise for India?
August 9, 2011

Following S&P's downgrade of the US sovereign debt rating, how should Indian investors position their equities.


Author : Manjunath Gaddi



 US ratings downgrade: blessing in disguise for India?

The Standards and Poor’s (S&P) ratings agency has rated the long-term sovereign credit rating for US to AA+ from AAA on 5 August 2011, with a negative outlook. However, the short-term credit rating still stays at the best – A-1+. The S&P in the same report has stated that it can lower the credit rating from AA+ to AA within the next two years if, “we (S&P) see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case.”

A knee-jerk reaction by the markets

US equity markets including the global markets have reacted negatively to the above news. The SENSEX did correct by over 387 points or 2.2% on 5 August 2011. S&P had kept the US long term sovereign ratings with a negative outlook since 18 April 2011. Thus, the knee-jerk reaction is temporary and was expected as the market was well awareThe delay in the US Congress reaching a consensus in raising the debt limit has indicated the lack of political willingness to resolve the domestic crisis speedily which has cost the US its AAA rating.

Silver lining for Indian economy and market

The rating downgrade of US currently has negatively impacted the equity market, but can lead to long term benefits for Indian economy.  The long-term sovereign debt of India is currently rated as BBB- by S&P while, the gross debt of many developed countries which are experiencing debt problems have a better sovereign debt rating. Table 1 shows the general debt of the countries as a percentage of their GDP. Some of the figures are estimates.

Table 1: Public debt as a percentage of GDP for India and other countries


Country
2009
2010
2011
2012
2013
2014
2015
2016
Estimates Start After
India
71.1
69.2
68.2
67.7
65.3
63.3
61.6
59.9
2010
Greece
126.8
142.0
152.3
157.7
157.0
152.5
149.4
145.5
2010
Iceland
91.7
96.6
103.2
97.1
92.1
85.3
80.9
73.8

 

Italy
116.1
119.0
120.3
120.0
119.7
119.3
118.7
118.0
2010
United Kingdom
68.3
77.2
83.0
86.5
87.4
86.5
84.4
81.3
2009
United States
84.6
91.6
99.5
102.9
105.6
107.5
109.4
111.9
2009
Source: IMF World Economic Outlook Database, April 2011

Many developed countries have a better rating but higher debt to GDP ratio than India. Therefore, India can make a case to S&P to consider upgrading the rating for India. Indian economy and the banking system have the ability to weather crises and return back to normalcy post the crisis. This has been proved post the Asian currency crisis as well as the 2008 global financial crisis.

So, a ratings upgrade for India can mean that the Indian government can raise debt from FIIs at a lower rate. This is important on the backdrop of that India is expected to invest US$ 1 trillion into infrastructure space between 2012 and 2017 and the Indian government is expected to fund about 50% of that. Hence, a ratings upgrade will definitely help to lower the interest expense for the infrastructure debt.

Currently, the economic growth in India is slowing down on account of tight monetary policy by the RBI, which is a result of  high levels of Inflation. Higher commodity prices (crude and metals) have accounted for the high levels of inflation along with higher food inflation. Due to the AA- credit rating of US, the commodity prices have corrected. The rating downgrade to US and the lowering of the commodity prices will definitely help cooling the Indian inflation. The lower levels of inflation can lead RBI away from a tight monetary policy and can allow India to grow faster, once the RBI stops its tight monetary policy.

The Indian equity market as represented by SENSEX is undervalued with the 1 year Forward EPS at 14.83X, while the long-term average is at 17X.


Actions for Investors

Investors who have invested into India for the long term either through SIP mode or lump sum can continue with their investments. With the markets correcting now, it presents an opportunity for investors to enter into the market in lump sum mode as we expect the ratings downgrade to be beneficial for Indian economy. Investors can choose to buy into the market on dips however, must be brave enough to weather the short-term volatility.


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