Rating upgrade by S&P acknowledges India’s improving economic scenario but inflationary pressures remain.
It has been a good week for the Indian economy, with Standard & Poor’s (S&P) upgrading India’s sovereign rating to stable from negative. The move ratified the fiscal consolidation steps outlined in the Union Budget 2010-11 proposals, while acknowledging the improving economic landscape and growth prospects in India (S&P factors in eight per cent growth in FY11).
The significant step comes at a time when country risk is coming back into the picture with default worries (measured by sovereign default swap spreads) heightening, with respect to Greece and the resultant contagion risk to other member-countries of the EU. Fiscal profligacy is threatening sovereign ratings of the US also, with rating agencies sending out a warning recently.
The worrying factor is the runaway inflation, which S&P admits as the key factor that could impact current macroeconomic and interest rate environment, though it may be finding a bridle. The annual rate of inflation on the WPI for the week ended March 6 was 14.16 per cent, down 90 bps week-on-week.
Analysts believe the low base effect will wear off by April, although the excise duty and fuel price hike will push up inflation by 100-150 bps according to an Edelweiss research report, hitting a peak of 11-12 per cent before softening. It expects the WPI to settle at about seven per cent by December 2010.
Meanwhile, government bond yields have softened marginally, with benchmark 10-year gilt yields sliding 10 bps on March 18 to 7.89 per cent.
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Most analysts believe the yields should move up, as RBI will act soon to reduce inflationary pressures. “RBI’s move will be calibrated to avoid impacting growth,” suggests Yashika Singh, head, Economic Analysis, Dun & Bradstreet India.
However, the flush of liquidity in the markets is seen in easy overnight money market rates, which averaged 2 bps over the RBI’s reverse repo rates. Banks parked about Rs 25,190 crore on March 18 in the RBI’s reverse repo window.
S&P has also upgraded the long-term credit counterparty ratings for 12 banks from negative to stable based on the sovereign rerating.
Analysts believe the sovereign rerating will increase the confidence of global investors in India and the Sensex has responded in kind, jumping 0.5 per cent in two days. However, the consensus view is that the market appears fairly valued and the next triggers will have to be from a good monsoon and strong earnings growth.