International rating agency Standard and Poor's (S&P) decision to downgrade India's local currency debt from investment grade to junk grade is definitely not a piece of information to be ignored. Yet, the Indian equity and debt markets decided to junk the rating. The stock market barometer BSE Sensex closed 16 points lower at 3,024 on Friday after touching a low of 2,994 in opening trades.
In the government securities market, the yield on the benchmark 10-year government bond closed at 7.17 per cent, as against the previous close of 7.16 per cent. Market sources unanimously agree that the rating action is of no major consequence and the new rating will not have any material impact on foreign institutional investors' (FII) allocations to India. Sentiments, however, continue to be weak.
There is no denying the fact that the downgrade by the top rating agency is a telling statement on the health of the Indian fiscal situation, but that isn't anything new. "The country's public finances has always been a cause for concern," says U R Bhat, chief investment officer, Jardine Fleming.
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It is not that the markets are unaware of this harsh realities. And it clearly shows in the equity valuations. "All the pessimism is already being reflected in the equity valuations," says Nilesh Shah, head, fixed income at Franklin Templeton Investment Management.
In the whole gamut of factors driving FII allocations into equities, country risk and ratings is the not the only parameters. "Equity investors are more bothered about ground realities like the growth expectations and corporate profitability," says Shah. Also, most FIIs benchmark their allocations against the MSCI indices. "The composition of the MSCI index is based on a market-capitalisation weighted model for which this downgrade has no implication," Shah continues.
Market players endorse the view that the rating downgrade is a natural consequence of the government back tracking on disinvestments. "It's the fear that till now Shourie was selling many companies, and now he may not be able to sell any, which is being reflected in the downgrade" says R Madhavan, chief economist, Bank of America.
The way the disinvestment programme gathered pace since the beginning of the year had set a long term direction for economic reforms and fiscal correction. That has now been derailed.
It is not as though equity markets haven't discounted this. Shares of public sector companies took a severe beating on the bourses when the government back-tracked on the disinvestment of state-owned refining companies, Hindustan Petroleum and Bharat Petroleum. In the past one month alone, HPCL lost about 30 per cent while BPCL lost 33 per cent in market capitalisation. On an average PSU stocks lost about seven per cent while the BSE Sensex lost two per cent.
The only other serious threat of such a downgrade to the markets is through change in interest rates. A lower rating typically means that bonds must carry higher rates. However, bankers point that it is unlikely that rates will be hiked. It would still be smooth sailing for the government to raise resources because credit demand is subdued and banks continue to be overweight on government securities. Having said that, it is not a season to celebrate for equity investors.
Jardine Fleming's Bhat says that foreign investors are fully aware of the state of the Indian economy and the inherent risks associated with it and thus the S&P downgrade should not lead to any panic selling. The sentiment in the domestic equity markets still looks gloomy and foreign investors may shy away from taking fresh investment calls, he adds.
The latest Merrill Lynch domestic fund manager survey only reveals that there is growing scepticism in the equity market. While fund managers continue to believe that the market is grossly undervalued-- the consensus being market is undervalued 15-25 per cent--the bullishness has reduced in the recnt past, with only 30 per cent now saying the markets are undervalued more than 25 per cent, the lowest reading in many months, the report says.
Even as fund managers are not bearish over a 12-month period, the number of sceptics is increasing in number. Almost 50 per cent of the fund managers now expect markets to stay below the 4000 mark even a year from now. In fact, the survey reveals that only 20 per cent of the fund managers would buy if markets rise 10 per cent from current levels. Then again, in line with reduction in optimism on markets, only 10 per cent of funds are now underweight on cash. Nearly, one-thirds of the fund managers polled in the survey have cash levels of over 12 per cent now. A bigger concern is that corporate profit expectations have declined on the back of poor monsoons and a weakening trend in global markets. Only 30 per cent of the fund managers polled expect a strong improvement in profits compared to double that number in the previous few months.
In the past many months FIIs haven't been very active in the domestic equity markets. With the spate of bad news continuing unabated, it is unlikely that there is going to be any reversal in this trend.