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How will India's rating affect stock investors?

Jul 4, 2013

India today stands at a risk to be the first BRICS nation to get the 'junk' status for its sovereign rating. With the Indian government failing to put its act together to save the country from this disgrace, the global rating agency, Standard and Poor's (S&P) has threatened to peg down India's sovereign rating to junk status. The other two big rating agencies too share a negative outlook for India citing concerns over the deterioration in macroeconomic fundamentals of the nation.

The dire consequences of the downward spiral in credit ratings remind us of few such weak economies. The downgrades to junk status of the debt-ridden economies of Greece, Cyprus, Portugal and Ireland had created shockwaves in the global markets. Greece, for instance, found it quite difficult to reduce its deficit via borrowings since the downgrade ensured that investors shy away from investing in Greek bonds. Consequently, Greece was compelled to pay higher interests on its bonds to attract investors and raise money at higher costs. Junk status also led to increased restructuring of the existing debt making the country mired in debt crisis. Thus, junk status not only implies dearer money or difficulty in raising money, but also brings the threat of further downside to the economy.

Red flags have already been raised with respect to state of affairs of the Indian economy. In its fifth Financial Stability Report, the Reserve Bank of India (RBI) warns of the ramifications of the possibility of the ratings cut for Indian corporates and Indian banks. The junk status would make the overseas borrowings expensive both for the government and the corporations. Indian corporates are already facing the high-interest rate burden. Even the best rated corporates, for instance, are also compelled to pay an interest rate which is nearly 2-3% higher than the risk free rate. Ratings downgrade would further add to their woes impacting the availability and the cost of foreign currency borrowings. The same holds true with banks. The higher overseas borrowings costs as a result of ratings downgrade, would impact their margins in a big way. Thus, repercussions of a poor credit rating can be highly problematic and can adversely affect all the sectors of the economy directly or indirectly.

Most importantly investors need to be aware of companies that have substantial exposure to foreign debt. The bond issuances of several corporates including Tata Steel and Bharti Airtel are already rated as junk, although the sovereign rating is yet to face the disgrace. Thus, downgrade in ratings or even its likelihood should raise alarms in the minds of the investors who have invested in stocks of leveraged companies or ones with overseas debt exposure. Investors should also be particularly vigilant while investing in domestic corporate bonds and plan their investment strategies well.

Shweta Daptardar-Mane

Shweta Daptardar-Mane, has an MBA (Finance) degree and over five years of equity research experience. She passionately tracks the Banking and Finance industry and follows the macro developments in the economy, particularly the central bank monetary policy. She is deeply inspired by not only Buffett's investment acumen, but also by his infectiously charismatic, down-to-earth persona. Shweta is the contributor to our large cap franchise, StockSelect.

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