With economic growth slowing and inflation rising, doubts have started to surface about the sustainability of the much-touted India story. A recent report by HSBC Holdings Plc. hit the nail on the head by asking, “India: has miracle turned to myth?”
It’s in this context that the country’s credit analysis by rating agency Moody’s becomes interesting. The report flags all the usual concerns: inflation, the slippages in fiscal deficit, the farm loan waiver, the sixth pay commission recommendations, political uncertainty, and so on. Yet, Moody’s keeps the Baa3 investment-grade sovereign rating for external liabilities as well as the government’s local currency bond rating of Ba2 intact.
What are the reasons? Moody’s comparison of India with other countries with similar ratings provides some clues. The rating agency agrees that India’s fiscal deficit is considerably higher than the Ba or Baa rated median. It says the Central government’s debt ratio is still an outlier among peer countries, while the government’s interest to revenue ratio is the highest in the cohort, pre-empting funds from being spent on much-needed infrastructure and social services.
However, these debits are balanced by the credits. These include the lowest external debt to GDP ratio in the cohort, the external debt to current account receipts much lower than the median, an excellent external debt to foreign exchange reserves ratio and a low “external vulnerability indicator”.
That’s the reason Moody’s keeps real GDP growth for fiscal year 2009 at 7.7%, driven by a high gross investment to GDP ratio of 36, funded by a high savings to GDP ratio of 35.1.
What then explains the severe underperformance of the Indian markets relative to others this year? More importantly, is the weakness of the rupee a sign of a lack of confidence in India?
What comes through from anecdotal evidence from corporates is that years of exceptional growth have led to severe strains in terms of getting skilled manpower, raw materials, inputs, components and so on. In other words, this slowdown is a problem of plenty.
That’s why Moody’s report says: “In the absence of higher absorptive capacities within the economy, Moody’s has long felt that the RBI’s dilemmas could lead to a prolonged tightening bias in its monetary policy.”
As HSBC’s Robert Prior-Wandesforde put it while answering whether India’s miracle has turned into myth, “The answer is no, although perhaps the strong growth and low inflation of recent times was not quite as miraculous as many believed.”
“In our view, part of the success was cyclical, reflecting the benefits of very loose policy conditions which were correctly tightened as the economy began to hit supply-side constraints... We still expect real GDP growth to average 7% in 2008-09. This would be the worst performance for six years, but far from disastrous, except in a world of euphoric expectations.”
True, but the stock market did have euphoric expectations and current valuations indicate that not all of them have been jettisoned.
GAIL gains from low subsidy provision
State-run GAIL India Ltd has shed about 5% in market value since it announced its March quarter results. The reported numbers were higher than most analysts’ expectations, with operating profit rising by as much as 92.6%, but they were propped up by a rather low provision for subsidy sharing at Rs387 crore.
In the year-ago March quarter, when the subsidy burden for the sector was much lower, the provision was higher at Rs500 crore.
GAIL’s current provisioning is based on the estimates the government communicated to the company this March. Analysts, however, feel that the final figure could be higher simply because under-recoveries were much higher last fiscal year.
GAIL’s liquefied petroleum gas business reported an operating profit of Rs379 crore, compared with a loss of Rs51 crore in the year-ago period. The petrochemicals business reported a healthy 20% year-on-year increase in operating profit, thanks to an increase in global petrochemical prices and a 10% rise in volumes.
Being the chief transporter of gas in the country, GAIL is expected to benefit from the increased production of gas in the east coast. What’s more, the risk of a fall in transmission tariffs stands reduced as rates have already dropped in the past two years.
But that’s not to say there is no risk of tariff reduction whatsoever. There is also a possibility that the subsidy burden may increase in the future, especially with crude rising to even higher levels. In fact, with crude oil price rising, there’s also the possibility that feedstock prices will increase for its petrochemicals business.
But the way things stand currently, the possibility of an upside outweighs the downside potential. Apart from the expected increase in volumes, the company also owns stake in a number of exploration and production (E&P) blocks. Besides, the company’s plans to provide city gas distribution services will add value in the long term. GAIL also has the least exposure to subsidies, which makes it one of the best plays in the Indian oil and gas sector.
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