The rating downgrade

LAST TUESDAY, STANDARD & Poor, a leading international rating agency lowered India's sovereign long-term local currency rating from the existing BBB to BBB-. It also changed its assessment of the outlook for the economy from ``stable'' to ``negative'' but has left the short-term local currency rating as well as all the foreign currency ratings untouched for the moment. A day later Moody's, the other prominent rating agency, followed suit by announcing its own version of downgrades. The terminology of the raters and the methodology used to arrive at the ratings are technical and as many experts say both unpredictable and inscrutable as well. Moreover, it is still debatable whether a change in ratings will have the same impact on India as they will for a country whose economy is more exposed to and integrated with the outside world. The major negative fallout for now is that Indian corporates who want to tap the external commercial borrowings will have to pay more. The saving grace is that such borrowings are down to a trickle and given the recessionary conditions unlikely to perk up soon. The other feared consequence is a higher domestic interest rate structure which might become necessary to attract and retain capital and underpin the rupee which might come under speculative attack. Even that is unlikely to materialise given that India is not yet on a full convertibility regime. Although the linkages between the domestic economy and the outside world are becoming more pronounced by the day, there is no reason to fear an immediate flight of capital consequent on a rating downgrade.

However, the lowering of the country's rating by a notch does cause concern in more general ways. The raters have based their rationale entirely on the deteriorating state of the public finances, the failure to rein in the fiscal deficit especially, and on the tardy pace of the reforms. The budget deficits of the Centre and the States together might exceed 10 per cent of the GDP, which will place India in a worse position compared to some other countries similarly rated. The much talked about disinvestment programme has had a tardy record over the years. Not only have the budgetary targets set for public sector sale remained hopelessly unachievable, but the failure is also a strong indication of the absence of political will to support the reforms. All those are very well known. In fact, policy statements from the Government and the RBI have never glossed over the shortcomings. But for the rating agencies they are enough to convey the downgrades, never mind that at present India is still strong on fundamentals - an expected GDP growth rate of 6 per cent, external reserves of $43.6 billions, one of the lowest inflation rates of recent times and a very manageable current account deficit.

One positive way of looking at the latest rating downgrades is to view them as a wake-up call for policy. Official reaction has, however, not been so sanguine, with Mr. Yashwant Sinha characterising them as being based on a wrong assessment of the economy. The Finance Minister, along with some others, has also pointed out that the raters are not infallible, as spectacularly demonstrated by their failure to read the East Asian crisis in 1997-98. For all such posturing, official policy will no doubt heed the warnings conveyed through the downgrades. Foreign direct investment into India is one area that will see some deleterious consequences. At a time when the country is passing through a crisis of confidence - the UTI fiasco, the Enron debacle and the complete breakdown of consensus among political parties over key economic decision-making are all taking their toll - the lowering of rating does aggravate the woes.

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