It’s never a good sign when a country’s finance minister is telling people not to panic.
In India on Wednesday, Pranab Mukherjee called for calm after Standard & Poor’s lowered its outlook for Asia’s third-largest economy and warned it is considering downgrading the country’s sovereign debt rating to below investment grade.
“There is no need for panic,” India’s Finance Minister told reporters in New Delhi. “The situation may be difficult, but we will be surely able to overcome [it]”
India’s economic and fiscal woes are mounting amid slowing growth and persistent inflation. The country is saddled with a ballooning fiscal deficit, a relatively high debt load and a massive infrastructure shortfall.
Making matters worse, its parliament is mired in political gridlock that has prevented the government from passing key reforms during the past two years and is unlikely to be resolved before national elections in 2014.
Citing these concerns, S&P on Wednesday lowered its outlook for India to “negative” from “stable.” India is now the only member among the so-called BRIC group of countries (Brazil, Russia, India and China) with a negative outlook.
“The outlook revision reflects our view of at least a one-in-three likelihood of a downgrade if the external position continues to deteriorate, growth prospects diminish, or progress on fiscal reforms remains slow in a weakened political setting,” S&P credit analyst Takahira Ogawa said in a statement.
A downgrade of India’s sovereign debt rating to “junk” status would have major implications for investors as it would raise the cost of borrowing and increase credit pressures on an already slowing economy.
Endowed with a relatively young population and a fast-rising middle class, India enjoyed above average economic growth of 8 per cent or more for much of the past decade.
In the past year, however, its economic prospects have dimmed significantly as its fiscal position has worsened. S&P is forecasting India’s gross domestic product will grow by 5.3 per cent this year.
Last week, India’s central bank cut lending rates for the first time in three years, in hopes of spurring growth. The strong need for economic stimulation was underlined by the fact that the rate cut was made despite an inflation rate of 9.5 per cent.
Mr. Mukherjee called the S&P outlook revision “a timely warning.” He has vowed to reduce India’s fiscal deficit, which widened to 5.9 per cent of GDP during India’s most recent fiscal year, well above the government’s 4.6-per-cent target.
Analysts and economists have called for India to reduce fuel subsidies, impose a goods and services tax and reduce restrictions on foreign ownership, to increase revenue and put its fiscal house in order. However, the government has been paralyzed by a wave of corruption scandals that have prevented it from passing reforms.
Nick Chamie, global head of emerging markets research at RBC Dominion Securities in Toronto, said the threat of a downgrade of India’s debt rating to junk status could be a catalyst to break the legislative impasse.
“They are going to have to make macro and micro economic reforms to put India’s economy on a sustainable high-growth path. They should be on that path already but there are a number of embedded problems and constraints in achieving that. This will only increase the domestic pressure, whether that is social pressure or political pressure,” Mr. Chamie said.
“I think it spells a difficult period ahead for India.”