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Junk Rating for India a Done Deal

The cut in India’s credit rating outlook to negative by ratings agency Standard and Poor’s (S&P) has prompted market watchers to say that it is only a matter of time before India gets downgraded to junk status given its poor record in managing fiscal problems.

BOMBAY, INDIA: A sign board 'Mumbai' is placed near the Taj hotel at the famous landmark the Gateway in Bombay, 13 May 2005. Since independence in 1947, regional advocates in India have called for a change in many place names to reflect the wide linguistic and ethnic variations in the country of one-billion-plus people that spans the Himalayans in the north to the meeting of the Indian Ocean and Arabian Sea in the south. AFP PHOTO/Sebastian D'SOUZA. (Photo credit should read SEBASTIAN D'SOUZA/AF
Sebastian D'souza | AFP | Getty Images
BOMBAY, INDIA: A sign board 'Mumbai' is placed near the Taj hotel at the famous landmark the Gateway in Bombay, 13 May 2005. Since independence in 1947, regional advocates in India have called for a change in many place names to reflect the wide linguistic and ethnic variations in the country of one-billion-plus people that spans the Himalayans in the north to the meeting of the Indian Ocean and Arabian Sea in the south. AFP PHOTO/Sebastian D'SOUZA. (Photo credit should read SEBASTIAN D'SOUZA/AF

“I won’t be surprised if the S&P downgrade actually happens. It won’t happen in the next 12-18 months because the data that S&P looks at are unlikely to change materially in the next year, (but) I expect it to take place closer to 24 months,” Anita Yadav,Managing Partner at corporate bond brokerage and asset management firm, SJ Seymour Group, told CNBC on Thursday.

The ratings agency on Wednesday cut India's outlook citing its large fiscal deficit and expectations of only modest progress on reforms given political constraints. The lowered outlook jeopardizes India's long-term rating of BBB-, which is the lowest investment grade rating. It assigned a one-in-three chance to an actual downgrade within the next 24 months.

Rohini Malkani, an economist at Citigroup in Mumbai, agrees that odds of a rating downgrade are “high,” as India will most likely meet the conditions outlined by S&P for the downgrade. These include deterioration in the country’s balance of payment position, diminishing growth prospects and slow progress on fiscal reforms in a weakened political setting.

“The current political gridlock and parliamentary elections in 2014 should result in only modest progress on fiscal reforms. We expect the center’s deficit target of 5.1 percent to slip to 5.5 percent for 2012-2013,” Malkani said.

She adds that there is a risk of ratings agencies Moody’s and Fitch following suit as well.

Nearly 60 percent of countries that have an outlook downgrade face a ratings downgrade in seven months, according to research by Citigroup.

Cyrus Daruwala, Managing Director at advisory firm for financial services companies, IDC Financial Insights, says many institutional investors already interpret India’s current credit rating as “junk status” based on the current state of its financial sector and economy.

“(Indian) stocks have been declining, so has the rupee, the country has a wide current account deficit, growth is slowing… India has no light on the horizon,” he said.

Daruwala sees India’s economic growth slowing down to 5.5-5.9 percent in fiscal year 2012-22013. “We had an analyst briefing with the Ministry of Finance yesterday early morning. Finance Minister Pranab Mukherjee seemed fairly bullish, that for fiscal 2012-2013, the Indian economy would expand at 7 percent. We don’t buy that,” he said, pointing to slower domestic consumption and tight liquidity conditions.

Stocks to Fall, Rupee to Rise

Market watchers agree that Wednesday’s downgrade will have an extended, negative impact on sentiment, particularly among retail investors, as well as the rupee.

“Retail investors have herd mentality and are going to be impacted by this move. I expect a further selloff in the equity markets, particularly with blue chip stocks. Investors stand to loose 12-15 percent (in the value of their) portfolios by the end of the second quarter,” Daruwala said,

Foreign inflows into the country’s equity market have already slowed substantially this year largely because of uncertainty over the government’s tax policies. So far this month, overseas investors have put just $172 million into Indian equities, compared to an average of $3 billion a month in the first quarter of this year, according to Reuters.

Daruwala says low investor interest in Indian stocks and bonds is going to take the Indian rupee further down. He forecasts the currency to fall to 55 against the U.S. dollar by the end of the year.

Growth Is Still a Bright Spot

But despite the gloom, the fact that India can still manage to grow around 6-7 percent is a silver lining for investors. According to Elena Okorochenko, MD & Head of Asia-Pacific Sovereign Ratings at S&P, India’s “impressive” growth trajectory is what has prevented an immediate downgrade of the country’s credit rating.

“Growth is quite impressive compared to many other countries and that’s what supports India’s ratings,” Okorochenko saidon CNBC Asia’s “The Call”.

One of the fastest growing economies in the world, India’s GDP expanded 6.1 percent year on year in the fourth quarter of 2011, its weakest annual pace in nearly three years.

Steve Watts, President, Asia-Pacific Japan at SAP told CNBC Asia's “Squawk Box” that his view on India, which accounts for one-fifth of the German software maker’s business, has not changed after the downgrade.

“India was my most successful business across APJ (Asia Pacific-Japan) last year in terms of growth, (we have a) big SME business as you would imagine with a market like India,” he said. “India for me is very important and I must admit, the credit ratings, I get it, but business continues.”

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