»5 Minute Wrap Up by Equitymaster

On This Day - 8 AUGUST 2011
How bad would US downgrade be for India?

In this issue:
» India Inc defers overseas borrowing programs
» FM still optimistic about India's growth
» So no need for economic stimulus for India
» Is it doomsday for IT stocks?
» ...and more!
--------------------------- WebSummit On Global Crisis With Ajit Dayal --------------------------

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The Monday morning blues have been accentuated by the US debt downgrade over the weekend. In fact, for investors it appears to be more of Monday morning 'red'. The Indian stock markets have followed their global counterparts and have suffered a heavy meltdown. So this gets us thinking as to what the US debt downgrade would spell for India in particular.

We are not exactly delinked from the US. It is a major client for nearly all of the exporters. Therefore any recession or slowdown in demand from US would impact the earnings of the export focused firms. To add to this, the domestic demand environment has slowed down as well. This was on account of the monetary tightening measures adopted by RBI to control inflation. Therefore, the domestic demand may not be able to offset the slowdown in demand from overseas. This spells trouble for Indian firms.

But is this problem new? US has been in a crisis since 2007 when Lehman Brothers collapsed. In reality, the crisis started when the banks decided to give loans to people who did not qualify for it.. But then that's history. Nonetheless, the fact is that US has been in crisis for a while now. The recent downgrade is just finally accepting the fact that US is in crisis. The Indian exporters have already learned to live and work around with clients who have tightened their purse strings. They have learnt how to negotiate with them. They have also learned how the crisis and changes in regulatory environment can be used to get better and more work from the clients.

Therefore, the recent selloff does not spell trouble for India. These risks could already be accounted for in the stocks. True there may be more crashes to come due to global volatility. But these should be treated as an opportunity. An opportunity to pick up fundamentally sound companies. The market crash is giving us an opportunity to get these stocks at cheaper valuations.

Do you think India would be affected in a major way by the US debt downgrade? Share your comments with us or post your views on our Facebook page.

 Chart of the day
The US debt has been downgraded by the rating agency, Standard & Poor's (S&P). The exact quantum of debt outstanding is around US$ 15 trillion. As reported by a leading daily, foreign countries own nearly US$ 4.5 trillion of this amount. And the emerging markets are part of the top 15 countries to which US owes the money. India is no exception. Currently, India's exposure to US debt stands at US$ 41 billion. This puts India in the 14th position of the top 15 countries having the highest exposure to US debt. China ranks first with a staggering US$ 1.15 trillion exposure.

Data source: The Mint

The downgrade of the US' credit ratings may make little or no difference to the fundamental prospects of India Inc. But for the fact that the cost of short term borrowings just got steeper. At a time when domestic credit is unviable, thanks to the RBI's strict monetary tightening, foreign money is the only recourse. The latter has been at least 5-7% cheaper than domestic debt and the hedging costs have also been low. But most of that changes with the downgrade of the US' credit rating. For the uninitiated, the yields for most international bonds are linked to US Treasuries. But with the US treasury papers themselves commanding a higher rate, the borrowing cost for corporate automatically gets dearer. While the same may get evened out in the long run, the short term pain itself could be very taxing for companies that are heavily dependent on leverage. What is good here is that the notion of 'cheap credit' is slowly getting phased out. That is expected to bring in more rational re-pricing of risk and allocation of funds.

The recent downgrade of US debt by the credit ratings agency Standard & Poor's has sent a wave a panic across global financial markets. Indian stock markets, too, have witnessed steep declines in recent times.

Addressing the captains of Indian industry at the recent conference, Finance Minister Pranab Mukherjee assured that India was capable of achieving high growth rates despite the ongoing external shocks. We are of the view that though the panic may squeeze liquidity from the markets as foreign institutional investors (FIIs) take flight; the debt crisis in the developed world does not significantly alter the fundamentals of our long term domestic growth story. Nonetheless, we must not forget that we have our own internal monsters such as inflation and corruption to deal with. Barring these challenges, India is poised to lead the global economy along with the other emerging economies.

With the risk of another recession in the developed world looming large, will the Indian Government play the economic stimulus card all over again? Not quite if a leading business daily is to be believed. For starters, the current economic situation in India is different than the period of 2008-09. Right now, the Government is in fiscal consolidation mode. In other words, its expenses exceed its income by quite a bit and any further stimulus would mean putting this number in even more danger.

Also, it is quite possible that the Indian central bank, easily one of the most hawkish in the world, stops its interest rate hiking exercise. This can happen if global commodity prices fall and consequently, inflation in India cools down. Hence, there is a chance here that even without the Government giving a stimulus shot, the economy could be boosted on account of the RBI's measures.

However, it would be wrong to completely rule out fiscal stimulus from the Government. It could well become a possibility if the developed world plunges into a recession worse than imagined. Here, the Indian Government may have to step in to pick up the slack on account of severe slowdown in net capital inflows and trade balance. For the time being though, it is a wait and watch approach by the Government.

Software firms including TCS, Wipro and Infosys are heavily dependent on the US economy for their growth. Not only does a large chunk of their business come from the nation but around 90% of their revenues are also dollar denominated. Thus, they are hit on two fronts: slower growth and dollar exposure if the US faces a double-dip recession. Post the 2008 crash, IT stocks bore the brunt of slower growth, especially in their banking and finance verticals. So is 2011 a repeat of 2008?

In response to the current flow of bad news coming from the United States, IT stocks felt a bulk of the selling pressure last week, tanking over 6%. In initial trade on Monday, the BSE-IT index was down almost 5%. But is this sell-off justified? Firms like Cognizant and TCS are boasting of a robust pipeline, even in an uncertain macro environment. Only Infosys seems to be cautious about the future. However, if global disasters are averted, and the world economy keeps on chugging along, IT stocks may see a relief-rally. This is because these stocks currently have a lot of negative sentiment about slowing demand priced in.

Standard & Poor's wreaked havoc in the financial world when it downgraded US' debt from AAA to AA+ on Saturday. Indeed, this is hardly surprising given that US' debt had bloated tremendously which meant that a downgrade was in order. But one cannot help wonder whether S&P should be taken seriously. There is no doubt that the US is in a mess currently largely due to loose monetary policies of the US Fed over the years and over consumption by Americans fuelled by more debt. However, one cannot ignore the fact that the global credit crisis also adversely impacted US' debt situation. And in this, Standard & Poor's along with other credit rating agencies were also major culprits simply because they gave AAA ratings to mortgage-backed assets that have since turned into toxic waste.

That is not all. S&P gave Lehman Brothers, whose collapse triggered a global panic, an A rating right up to the month of its demise. And refused to accept blame even after Lehman collapsed. Indeed, one does not deny the fact that the US is in a bad shape. Its mounting debt burden at some time or the other was bound to blow up in its face. The question is whether S&P's has the moral right to downgrade US debt and be taken seriously when its tainted reputation has been exposed to the world.

In the meanwhile, the Indian stock markets recovered slightly after opening the day deep in the red. However, they still continue to trade below the dotted line. At the time of writing, the benchmark BSE Sensex was trading down by 120 points (0.7%). Among the stocks weighing on the index were Infosys Ltd and Tata Motors. All major Asian indices were in the red today with stock markets in Indonesia and South Korea leading the pack of losers.

 Today's investing mantra
"The people who are buying stocks because they're going up and they don't know what they do, deserve to lose money." - Jim Cramer

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