Mumbai: Little more than two years after Warren Buffett labeled India a dream market, the economy is expanding at the slowest pace in a decade and the nation’s debt ratings are at risk of being cut to junk.
In the last three months, ArcelorMittal and Posco scrapped plans for $12 billion of investments, while global funds pulled $12.6 billion from Indian stocks and bonds. The exodus drove the rupee to a record low and caused short-term borrowing costs to soar, sending the government’s two-year bond yield to the biggest premium to the 10-year rate in Bloomberg data going back to 2001. Even Buffett packed up and left, with Berkshire Hathaway Inc. exiting an insurance distribution venture.
Investors see little prospect of India tackling budget and current-account deficits that drove the rupee down 21% in two years as Prime Minister Manmohan Singh boosts food subsidies to woo voters before a May 2014 election. Standard and Poor’s said this month there is a one-in-three chance the nation will lose its investment-grade rating within two years, while Pacific Investment Management Co. sees a large chance of a cut in as little as 12 months. Last year’s economic growth of 5% compares with an average 7.6% in the previous decade.
“India’s image has been spoiled and I feel the country has more downside,” Raj Kothari, a fixed-income trader in London at Sun Global Investments Ltd, said in an interview on 13 September. “We are bearing the brunt of years of wrong fiscal policy. The government almost settled into inaction. I don’t think global investors are willing to bet on India in this scenario.”
Raghuram Rajan outlined a plan to give concessional swaps for banks’ foreign-currency deposits when he took charge as the 23rd governor of the Reserve Bank of India (RBI) on 4 September. That, along with the US Federal Reserve’s decision this month to continue monetary stimulus that has buoyed emerging-market assets, has helped the rupee pare some losses. Foreign funds have bought a net $1.97 billion worth of Indian shares in September and outflows from debt have slowed to $331 million.
The rupee has rallied 5.2% in September, after a 14% slide in the previous three months that was the worst performance among 24 emerging-market currencies tracked by Bloomberg. The BSE Sensex of local shares has climbed 6.6% this month as Rajan’s measures and the Fed’s policy boosted inflows. It fell 5.8% in the June-August period.
India’s smallest companies are trailing its biggest corporations by the most since 2006 in the stock market. The S&P BSE Small-Cap Index, a gauge of 431 companies with a median market value of $90 million, has tumbled 26% this year, compared with a 2.2% advance in the Sensex, where the median value of 30 firms is $16.7 billion, data compiled by Bloomberg show.
Rajan unexpectedly raised the benchmark repurchase rate to 7.5% from 7.25% last week to rein in inflation and eased some of the cash curbs the central bank, under his predecessor D. Subbarao, imposed to support the currency.
Investors remain sceptical whether RBI alone can fix the economy, which Goldman Sachs Group Inc. predicts will expand 4% the fiscal year through March. While the rupee has rebounded 10% from an unprecedented 68.845 per dollar on 28 August, Goldman sees a decline to 72 by the first quarter of 2014. Macquarie Group Ltd predicts a drop to 75.
“Investors, it seems, have some expectations from the new governor, but India faces long-term issues and they can’t be solved in a short period of time,” Kim Jin Ha, the Seoul-based head of global fixed income at Mirae Asset Global Investments Group, which managed $56.25 billion worldwide as of 31 July, said in a 17 September interview. Policy action not coordinated with local government might bring another headwind.
Weakened by corruption scandals and the loss of allies, Singh’s government has passed the fewest bills ever by an administration sitting a five-year term. That is allowing imbalances to build in Asia’s third-largest economy.
The current-account deficit widened to a record 4.8% of gross domestic product (GDP) in the fiscal year ended 31 March, while the 4.9% shortfall in public finances was the highest among the four largest developing nations. The World Bank estimates more than 800 million people live on less than $2 per day in India, where consumer-price inflation has held close to 10% for more than a year.
Data this month showed gains in wholesale prices unexpectedly accelerated to a six-month high of 6.1% in August. Every 10% decline in the rupee adds as much as 80 basis points, or 0.8 percentage point, to wholesale-price inflation, Nomura Holdings Inc. estimates show.
The rupee’s tumble prompted comparisons with the balance of payments crisis India faced in 1991, when the government airlifted gold to pledge as collateral for an International Monetary Fund (IMF) loan as foreign-exchange reserves slid. India won’t face a repeat of that situation as it has enough reserves for about seven months of imports, compared with 15 days back then, Singh said last month. The nation had a $247 billion currency stockpile as of 13 September.
“In the near term, we are more cautious on India,” Roland Mieth, senior vice president of emerging markets at Pimco Asia Pte Ltd, a unit of the company that runs the world’s biggest bond fund, said in an interview in Singapore on 16 September. Although an outright credit default remains unlikely, the chance of a sovereign downgrade by one of the major credit agencies is large in the next 12-18 months.
A cash crunch created by RBI to shore up the exchange rate caused short-term interest rates to exceed long-term ones, inverting the yield curve that gauges the length of investment against returns. Three-month government debt costs jumped to as high as 12% at the end of August, from 7.31% three months earlier. Two-year bond yields exceeded 10-year rates by as much as 272 basis points on 31 July.
Inverted yield curves typically reflect investors’ lack of confidence in an economy and presaged bailouts in Europe in the past three years. Greece’s two-year debt started paying more than 10-year securities a month before the government sought financial aid for the first time in 2010, while Portugal’s curve inverted a week before it sought a rescue.
India aims to narrow the budget gap to 4.8% of GDP in the fiscal year ending March 2014. That goal looks difficult to achieve as government spending increases, according to UBS AG. Singh’s administration has proposed a $21 billion-a-year programme to provide about two-thirds of India’s 1.2 billion people with low-cost grains.
I am quite surprised that the downgrade hasn’t happened so far, Bhanu Baweja, the London-based global head of emerging-market cross-asset strategy at UBS, said in an interview with Bloomberg TV India on 11 September. “I don’t think we can hit the 4.8% fiscal target unless we completely switch off the planned expenditure, which is going to hurt the economy further.”
Standard Chartered Plc cut its forecast last month for gains in India’s GDP in the year through March 2014 to 4.7% from 5.5%. CLSA Asia Pacific Markets and Goldman Sachs have lowered their estimates twice this quarter with CLSA now expecting 4.2%. Singh’s economic advisory body reined in its growth forecast this month and signaled interest rates wouldn’t fall until the rupee stabilizes and inflation eases.
India’s domestic savings has helped cap increases in public debt costs and the economy’s limited reliance on foreign borrowings has made it less vulnerable to currency risk, according to Moody’s Investors Service.
“Because of relatively high savings, the yields paid by the government haven’t shot up so dramatically that its repayment capacity is at risk,” Atsi Sheth, an analyst in New York at Moody’s, said in a phone interview on 18 September. “The rupee depreciation doesn’t significantly and immediately affect India because foreign-currency debt is about 6% of its total debt.”
Gross national savings as a percentage of India’s GDP stood at 29.8% at the end of December 2012, IMF data compiled by Bloomberg show. That compares with 13.1% in the US, 15.4% for Brazil, 28.5% for Russia and 49.5% for China.
Moody’s, which rates India Baa3, said in a report last month that expansion of food subsidies is credit negative as it will exacerbate the government’s weak finances. The company cut its senior unsecured debt and local-currency deposit ratings on State Bank of India, the nation’s largest lender, to Baa3 from Baa2 on Sept. 23. It also changed the outlook on its D+ financial-strength ranking to negative from stable, citing the worsening economy as a reason.
The SBI downgrade may affect India through the equity channel as outflows will affect the rupee, Vishnu Varathan, an economist at Mizuho Bank Ltd in Singapore said on 24 September. Some investors also perceive porous linkages between SBI and the sovereign, renewing concern that India’s credit rating may be downgraded, he said.
Credit-default swaps insuring the bonds of the government-controlled SBI, a proxy for the sovereign, against non- payment rose 106 basis points last month to 365 in the biggest jump since 2008, according to data provider CMA.
India may have to draw $9 billion from its reserves to fund the current-account deficit, C. Rangarajan, chairman of the Prime Minister’s Economic Advisory Council, said in a report released on 13 September.
Options signal rupee swings will widen, boosting investors’ risk. The currency’s one-month implied volatility has jumped to 16.52% from this year’s low of 7.53% in April. The gauge of expected swings in exchange rates is quoted as part of options prices.
India is not in a good place at all, said UBS’s Baweja. Given that a downgrade hasn’t happened so far and the economy is already on its knees, it’s difficult to know what the incremental negative could be from here. It could be massive capital flight from all the foreigners; that would certainly do it for many of these rating agencies.