Mumbai, Oct. 10: Standard and Poor's (SandP), the global credit rating agency, has said once again that there is a one-in-three chance that India's sovereign rating will be downgraded in the next two years.
The rating agency was re-asserting a view it expressed in June, squelching any hopes that the country's mandarins may have had of heading off the prospect of an ignominious downgrade after unleashing a reform blitz in the past month.
India now has a rating of BBB-, which is the lowest investment grade rating amongst the Bric economies. A downgrade will reduce the sovereign rating to the status of a junk bond.
"A downgrade is likely if the country's economic growth prospects dim, its external position deteriorates, its political climate worsens, or fiscal reforms slow," SandP said in a report on Asia-Pacific sovereigns released today.
Bond prices fell after the SandP warning and the BSE Sensex tumbled 162 points.
The government had been slammed by global rating agencies for its policy paralysis and issued dire warnings of a rating downgrade, which galvanised the government into action.
It first raised diesel prices by Rs 5 per litre and capped the annual consumption of subsidised LPG cylinders to six per household.
The Centre also announced steps to restructure debts owed by state electricity boards even as it took an important decision of permitting foreign direct investment (FDI) in multi-brand retail. It also raised the FDI in insurance to 49 per cent.
With the government promising more reforms, many had felt that the chances of a sovereign rating downgrade would now recede.
It was in June that SandP had warned of a sovereign rating downgrade. Earlier, it had downgraded India's rating outlook from stable to negative.
However, SandP continues to be wary on the fiscal front. The rating agency said that the Centre's fiscal deficit would be around 6 per cent of GDP for the current fiscal year against the targeted 5.1 per cent. This is largely on account of weaker-than-expected tax receipts because of weaker economic growth and higher-than-budgeted subsidies.
It further said the fiscal situation of several state governments had been adversely affected by the state power companies' weak and worsening financial conditions.
SandP went on to add that the Centre might have to brace for challenges on the political front. "After a long wait, the government seems to have re-ignited reform efforts, and that bodes well for the future development of the country. With two state elections, including Gujarat, which will be held in December 2012, the government has only a small window to implement reforms," it said, noting that the political cost had become apparent with one member of the coalition quitting.
According to the rating agency, the political condition could become more fluid ahead of the general elections in 2014.
"The foreign ownership reforms for the insurance and pension business are likely to become more challenging as they need parliamentary approval," it observed.
On the interest rate front, too, SandP sounded a note of caution, pointing out that sticky inflation would restrain the Reserve Bank of India (RBI) from cutting rates aggressively.
"The WPI is still above the RBI's medium-term target of 4 to 5 per cent. And the trade deficit remains relatively large in recent months. We, therefore, expect the RBI to remain cautious in conducting its monetary policy in the coming months," SandP said.
It, however, added that the outlook could be revised upwards to stable if the government succeeded in reducing fiscal deficit, improving the investment climate and reviving growth.