 "S&P hasn't said anything new and markets agree")
It is not cast in stone that the economy will continue to behave the way it did last year. The fact that the unthinkable happened when Chelsea beat Barcelona in the Champions League semi-final should make investors believe in the unthinkable.
Rating agency actions make headline news - and that’s about it. On the ground, realities are already factored in by the markets, and any negative or positive sentiment caused by rating agency actions is only temporary in nature. Markets are much more forward looking than rating agencies, who are, in fact, backward-looking and usually follow markets.
S&P downgraded Indian from BBB- stable (outlook) to BBB- negative (outlook). BBB- is the lowest investment grade rating, and any downgrade below that falls in the category of speculative investments.
[caption id=“attachment_288511” align=“alignleft” width=“380” caption=“The rating agency is reactive and will react when macro-economy factors improve or deteriorate. Reuters”] [/caption]
S&P has cited a widening current account deficit of 3.6 percent of GDP for 2011-12 from 2.6 percent of GDP for 2010-11, a rising fiscal deficit at 5.9 percent of GDP in 2011-12 against budgeted estimates of 4.6 percent of GDP and falling GDP growth at 6.9 percent for 2011-12 against 8.6 percent growth seen in 2010-11 for the downgrade.
The performance of Indian markets suggests that these have been factored in by the markets. The Sensex and Nifty are down 10 percent, ten-year bond yields are up 60 basis points and the rupee is down 15 percent on a year-on-year basis (at the end of April). S&P rating action is only an affirmation of what the markets have already factored in.
Impact Shorts
View AllThe outlook going forward is more important. S&P is not in the business of giving ratings based on market perception or based on outlooks. The rating agency is reactive and will react when macro-economy factors improve or deteriorate. If there is a sense of optimism that factors will improve from here on, markets will run up much ahead of that optimism coming true and vice versa.
Investors should shrug off S&P making headlines and look at the future to see whether there is a case for optimism or not. The fact that post the S&P downgrade of US debt from AAA to AA+ in August 2011 has led to a 7 percent rally in US equities, 60 basis point rally in US treasuries and a 6.5 percent rally in the dollar suggests the wide difference between market realities and rating actions. The US example is not to suggest that Indian markets will actually do well because of a downgrade, but if the perception is that factors are turning around for the better albeit slowly, India can do well going forward.
The macro economic environment has changed since April 2011. Inflation, which was trending higher in 2011 leading to rate hikes by the RBI, is showing signs of stabilising. Inflation is down from 9 percent and above levels to 7 percent and below, which prompted the RBI to cut the repo rate by 50 basis points in its April 2012 policy. The eurozone crisis, while still very much around, is not threatening to destabilise markets at present and FII (foreign institutional investors) flows have turned positive in the first few months of 2012.
The government has projected a fiscal deficit of 5.1 percent of GDP and a GDP growth of 7.6 percent. The deficit and growth targets are achievable if the global economy stabilises, the monsoon is on track and inflation keeps its head down. These will allow the RBI to cut rates further. It is too early in the day to predict that none of the targets set by the government will be met. While it is true that none of the targets set by the government for 2011-12 was not met, it’s not beyond the realm of possibility that targets for 2012-13 will be surpassed.
Arjun Parthasarathy is the editor of www.investorsareidiots.com, a web site for investors.
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