| Yashwant Sinha | ||||||
When international rating agencies announced a negative outlook on India’s sovereign rating in early August, the equity and bond markets barely reacted.
That was not because they disagreed with the assessment but because the rating actions confirmed what the market already knew. Sunil Gulati, head of investment banking at ING Barings, says: “Second-generation reforms have simply not taken off.”
An economist at a large US investment bank adds: “The market [index] is down from 6000 to 3300; that’s a verdict on economic reforms.” Ullal Bhat, chief investment officer, Jardine Fleming Asset Management, takes a slightly different view: “The outlook is negative, but given how bad things are in some east Asian countries today, there is a feeling that India is not doing so badly.”
Standard &Poor’s lowered its outlook on India’s sovereign rating on domestic bonds to triple B minus from Triple B. A day later Moody’s dropped its ratings on India’s sovereign domestic debt to Ba2 negative and foreign currency debt to Ba2 stable. The downgrades were, according to both agencies, caused by a worsening budget deficit, around 10% of GDP, and failure to implement tough economic reforms.
Asked to comment on the rating actions, finance minister Yashwant Sinha retorted: “I do not have to be told by the rating agencies that I have to take care of the fiscal situation. I have talked about that in my budget speech in March. We have introduced the fiscal responsibility bill in parliament… India is a democracy; we cannot cut the parliamentary process short … It is wrong to say that [economic] reforms are on hold.”
Sinha has reason to feel aggrieved. Ever since he presented a widely acclaimed budget in March, everything seems to have gone awry for him. As a series of financial scandals and bad news rocked the government in recent months, he has, at least on a couple of occasions, had to defend his job.
First, a stock market crash in early March crippled the Bombay Stock Exchange, the country’s oldest bourse, causing a payment crisis that left several banks reeling. In July, new trading rules on Indian bourses caused volumes to shrink dramatically and brokers boycotted the exchanges for a few days in protest. Then a scandal hit the biggest mutual fund – US 64 – managed by government-controlled Unit Trust of India. Faced with 20 million angry investors and demands for his resignation, Sinha acceded to a partial bail-out.
Last month, government-controlled Industrial Finance Corporation of India, the third-biggest long-term lender, defaulted on its bonds and the government hastily put together a Rs10 billion ($212 million) rescue plan. The largest development bank, government-owned Industrial Development Bank of India, is also seeking succour after a downgrade by a rating agency in July.
Budget deficit figures for the quarter ended June put out by the government confirm a worsening fiscal situation. The economy is slowing down and tax collection could be weak. Is there not enough evidence that things have turned for the worse?
But India’s external fundamentals are still strong, counters Rakesh Mohan, chief economic adviser to the government of India. Foreign exchange reserves are at over $40 billion and the current account deficit is under 2% of GDP. “We are in the midst of a global slowdown. Relative to countries such as the US, Japan and now Taiwan, we are still a growing economy. We may be worse than China, but our economic fundamentals are no worse than those of comparable or even stronger economies. So what is the benchmark for the rating action?” he asks.
He adds: “The government acknowledges that there is a fiscal problem. It has been shouting from the rooftops about this and introduced a fiscal responsibility bill in parliament. But it takes time to pass such laws.” On the downgrade of India’s domestic debt, Mohan says: “It makes no sense – the government will always honour its debt. Foreign investors in the government’s rupee debt might be affected through changes in the exchange rate, but it makes no sense to domestic investors.” The Indian government does not borrow from the commercial market abroad and state banks and institutions are the biggest investors in its rupee bonds. Government debt, S&P reckons, is close to 70% of India’s GDP.
Some officials privately say that the rating action raised hackles as it is seen as an attempt to pressure the government to settle the row with Texas-based Enron over its troubled power plant in western India. The company is not mentioned by either agency in their public releases. But an official from Standard & Poor’s, in an interview with Outlook, a local journal, asks how a country that faces growing power shortages could be so adept at losing the few foreign investors that put money into the energy sector.
That row is increasingly taking a political overtone. Enron stopped work on the project some weeks back and reportedly asked the government to buy out its $1 billion equity in the Dabhol Power Company. Enron chairman Kenneth Lay told the Financial Times in an interview on August 24 that US laws could prevent the US government from providing aid or assistance to India if the property of US companies were appropriated. That is seen as a veiled threat, particularly as it comes when the Bush administration is getting ready to remove the economic sanctions imposed on India in the wake of the nuclear tests in May 1998.
Bankers say that the Dabhol affair must have weighed on the rating agencies, but point out that the Indian government’s procrastination made things worse. One foreign banker says: “The government is being needlessly defensive about Enron. It should come out and say it’s a bad deal if that’s what it now feels.” Foreign investors might then even be persuaded that the contract was skewed in Enron’s favour, he says, adding that independent power producers in other developing countries have faced similar problems. The delay over sorting out the Enron issue or clearing the troubled privatization of Air India, which has no foreign suitors following Singapore airlines’ withdrawal, are symptoms of the political inertia that, as the rating agencies point out, has dissipated the coalition government’s will to push through reforms.
The rating changes are unlikely to affect adversely foreign investment in India. Foreign portfolio investors have invested $2.6 billion in the Indian capital markets so far this year, compared with $1.5 billion for the whole of last year. Foreign direct investment is also unlikely to be any lower than the $2 billion to $3 billion India gets each year. Jardine Fleming’s Ullal Bhat says: “Foreign investment is unlikely to be affected because there is so little coming in anyway. India is below investment-grade rating for foreign-currency borrowings.”
Also, few Indian companies borrow in foreign currency because interest rates on rupee borrowings have fallen. The National Thermal Power Corporation, a public sector company, was in the market refinancing a $120 million loan when the rating actions happened.
“We saw little impact on the deal. The issue was oversubscribed at an all-in borrowing cost of around 62 basis points over Libor, saving NTPC interest costs on the earlier fixed-rate loan,” says
N Chandrasekaran, chief general manager at the State Bank of India, the arranger for NTPC. The market, it seems, has its own logic.
