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

2. 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 India's 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 Governance
India’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 outlook
has led many to become more concerned, more uncertain.” – Gerard Lyons, Chief Economist and Global Head of
Research, 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
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3. 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-sector
Quantum of Impact of S&P Downgrade High Medium Low
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4. 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 years
Considering 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 India
Any move by S&P or other
credit rating agencies to
further downgrade India’s AA-
ratings would be a result
(rather than a cause) of
the Indian government’s
inability to pull the
economy 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
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