A non-event

Standard & Poor's upgrading of India's long-term foreign currency rating one notch to BB+ is, to a large extent, a non-event.

The rating agency apparently believes that India should continue to be rated below investment grade, in spite of portfolio investments pouring into the country in the last two years, in spite of one of the highest rates of economic growth in the world, and in spite of Indian paper getting snapped up in markets abroad at very competitive rates.

With the upgrade, we are now in the company of Egypt, Romania and El Salvador, so far as foreign currency ratings go.

The factors that led to the improvement in the rating, according to S&P, are the country's high and growing level of foreign exchange reserves, which "lower the external liquidity risk from its fiscal vulnerability".

Apparently, however, forex reserves of more than 20 times short-term debt and six times gross financing requirements are not enough for India to make it to investment grade.

S&P does not seem to have been influenced by its rival rating agency Moody's, which had upgraded India's foreign currency rating to investment grade a year ago.

The bugbear, of course, continues to be the fiscal deficit, which, according to S&P, continues to be "one of the worst among rated sovereigns, leaving it particularly vulnerable to any secular decline in growth rates or increase in interest rates."

The fact that there are no signs at the moment of that happening does not seem to have weighed with the rating agency. Nor does the change in rating have a big impact on the markets.

However, corporates borrowing abroad will now be able to get finer rates.

The news also cheered the rupee, but that seems to have been more the result of the large portfolio inflows in the last few days""the S&P upgrade merely provided the trigger for a further bout of appreciation.

Ratings upgrades have had no effect on dollar inflows in the past, and even long-term pension funds, such as Calpers, have had no problem investing in the country despite sub-investment grade debt ratings.

And so far as access to debt is concerned, Indian corporates have had no difficulty in raising foreign debt, while the World Bank is extremely eager to fund projects in this country.

Nevertheless, S&P's focus on the country's fiscal deficit is welcome, as it will serve as another reminder to the government that it needs to put its finances in order.

While it's true that interest rates have remained low in the past despite massive government borrowing, one reason was that corporate investment was relatively low and companies had accumulated large cash balances.

Once corporates start borrowing to fund capital expenditure, and if the government goes ahead with its grand plans to invest in infrastructure, interest rates could face upward pressure.

Further, a reduction in foreign portfolio inflows too could also lead to lower liquidity, while the Reserve Bank's ability to pump liquidity may be constrained if commodity prices stay high.

It is then that the higher fiscal deficits will start hurting growth, by crowding out private borrowing and investment. The government needs to make sure that doesn't happen.