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The Sovereign Rating (SR) scare for India

Recently, Standard & Poor (S&P) warned that India's SR will be downgraded if the country's economic growth does not recover. Bond yields spiked soon after the S&P red flag. Here's why India should take the warning seriously. Thread 1/11
SRs of 3 agencies - S&P, Moody's and Fitch are considered important. Currently, India is rated BBB- (Stable) by S&P, Baa2 (Negative) by Moody's and BBB- (Stable) by Fitch. Simply put, India is barely investment grade as per S&P and Fitch and a notch better as per Moody's. 2/11
Following are the reasons why SRs are important and why India should heed S&P's warning.

1. There is a clear correlation between bond yields/ spreads and SRs i.e. a poor SR could increase the cost of borrowings of Government as well as corporates. 3/11
Jaramillo and Tejada (2011) who analysed 35 emerging economies, concluded that an investment grade SR is far important than any other macro-economic parameter to keep interest rates low. The spreads of a BBB- country is 160 bps while a BB+ country has spreads of 440 bps. 4/11
2. Many international investors' mandate restrict investments to only investment grade countries. A downgrade, therefore, can cripple a country's access to global capital markets e.g. only investment grade instruments make it into the Barclays Euro Government Bond indices. 5/11
a) An event study done by Mugobo and Mutize (2018), over the period 2004 - 2014, to investigate the impact of SR change on foreign direct investment (FDI) in
South Africa concluded that there were evidences of a very significant relationship between FDI and SR change. 6/n
b) A study by Gande & Parsley (2004), across 85 countries, showed that downgrades are strongly associated with outflows of equity capital from the country being downgraded while improvements in country’s SR are not associated with discernable changes in equity flows. 7/ 11
3. Corporates too feel the pinch of SR downgrades. Usually the credit ratings of corporates are capped at the SR of its country of operations. A downgrade in credit rating leads to downgrade in credit rating of corporates too thereby hampering their financial flexibility. 8/11
A research done by Almeida, Cunha, Ferreira and Restrepo, of corporates across 80 countries affected by sovereign debt downgrades show that debt cost of corporates increased by 34-61 bps and CAPEX of higher rated corporates decreased by 10% on SR downgrade. 9/11
Further, a corporate raising financing in a country that has recently experienced a ratings downgrade may face restrictive demands from potential lenders i.e. a stringent covenant package, enhanced security, strict hedging requirements, sponsor guarantees, insurance etc. 10/11
To sum it all up, a sovereign rating downgrade at this juncture doesn't bode well for India. A downgrade would push India into a vicious circle that could take decades to overcome. Urgent measures are required from the Government to arrest the downslide towards downgrade. 11/11
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