The overseas borrowing costs of Indian companies could rise over the next two years if the government fails to meet its deficit reduction targets as this will adversely impact the sovereign credit rating of the country, analysts say . If the rating worsens, there will be fewer takers in overseas markets for Indian bonds and international lenders will charge more from Indian firms looking to raise money. The rating models used by international lenders factor in sovereign ratings, and a drop in the ratings would have an impact (on the rating of Indian companies and the interest rate they would have to pay),said Pankaj Karna, partner and head, M&A and lead advisory, Grant Thornton India, an audit firm.
India’s Fiscal Responsibility and Budget Management (FRBM) Act, 2003, aims to shrink revenue deficit, the difference between the government’s revenue receipts and revenue (or operational) expenditure to zero by 31 March 2009. In the financial year leading to the deadline, 2008-09, India and the government will likely be in election mode—the current government assumed office in 2004 for a five-year term. Economists do not expect the government to be in a position to control expenditure in an election year.
Finance ministerP. Chidambaram has said he expects revenue deficit to be 1.5% of GDP at the end of the current fiscal year (2007-08), a reduction of 50 basis points compared with the last fiscal (2006-07). If the government has to meet the targets set by the FRBM Act, it would have to reduce its revenue deficit by a further 150 basis points—in his Budget speech in February, Chidambaram had said the government was on course to achieving this.
Meeting this target has a bigger impact on India’s sovereign rating than is usually understood, said a retired finance ministry official who did not wish to be identified. It is seen as a sign that the entire political spectrum is in favour of fiscal prudence and any deviation would affect India’s credibility, the official added. Some analysts, however, do not see cause for alarm. “I don’t see a major danger at this point,” said D.K. Joshi, principal economist at rating agency Crisil, on the possibility of the government falling short of its target.
So far, the government’s attempt to squeeze revenue deficit has succeeded primarily on account of the sharp growth in tax revenue. “Maintaining momentum of revenue is critical for meeting FRBM targets,” added Joshi. Revenue growth has been spurred by an economy that grew by 9.2% and 9% over the previous two years. Forecasts estimate that India’s GDP will grow by over 8% in 2007-08 and 2008-09; Crisil’s own projection says the economy will expand at between 7.9% and 8.4% this year and 8.2% next year. Over the past few years, the combination of strong economic growth, introduction of the FRBM Act, and better government finances have encouraged international credit rating agencies to push India’s sovereign rating into investment grade.
Standard & Poor’s Rating Services raised India’s rating to investment grade in January after a gap of 15 years, while Fitch did so earlier, in August 2006. Moody’s raised India’s foreign exchange borrowings to investment grade in January 2004. An ‘investment grade’ rating for India increases the range of funds that can invest in bonds issued by Indian companies and has a favourable impact on the lending rates charged by banks.
Over the past couple of years, the average spread Indian companies pay in international markets for five-year debt has narrowed from 100 basis points over the London interbank offered rate (an interest rate standard) to about 50-60 basis points, said Anil Ladha, senior vice-president, debt capital markets, ICICI Securities Ltd. Currently, Indian companies generally pay an interest of about 6% for five-year overseas borrowings. “Spreads have kind of stabilized,” Ladha added.
The lower cost of borrowings, coupled with high economic growth, has pushed up the extent of overseas borrowing by companies. Data put out in May by the Reserve Bank of India (RBI) showed the external commercial borrowing by Indian companies between April and December 2006 at $9.2 billion (Rs37,720 crore), against $4.4 billion in the corresponding period of the previous year.
The growth in the value of ECBs is the outcome of buoyant domestic investment activity, said RBI. The finance ministry has, in recent weeks, tried to reduce the amount of foreign loans borrowed by Indian companies in an effort to reduce capital inflows that have helped the rupee rise to a nine-year high against the dollar, hurting India’s exporters.