Downgrade Risk Rises as Drought Threatens Deficit: India Credit

The weakest monsoon since 2009 is set to prevent Prime Minister Manmohan Singh from reducing the biggest budget deficit among the largest emerging markets, increasing the risk of a downgrade of India’s debt rating.

All the seven economists in a Bloomberg News survey predict the government will overshoot its deficit target of 5.1 percent of gross domestic product in the year to March 2013. Daiwa Asset Management Co. expects the 10-year government bond yield to rise as high as 8.40 percent by the end of this quarter, 28 basis points more than today. Comparable yields are 1.69 percent in the U.S., 3.33 percent in China and 9.64 percent in Brazil.

Below-average rainfall is stoking farm prices and keeping the Reserve Bank of India from cutting the highest borrowing costs among major Asian economies even as the slowest growth in almost a decade puts India’s investment-grade credit rating at risk. Crisil Ltd., the local unit of Standard & Poor’s, forecasts the budget gap will widen to 6.2 percent as Singh’s efforts to keep fuel and food affordable increase the government’s subsidy bill.

“Everything that can perhaps go wrong is going wrong for India,” Gaurav Kapur, a senior economist at Royal Bank of Scotland Plc in Mumbai, said in an Aug. 7 interview. “The deficit target was challenging from the beginning, and now a weak monsoon and slowing growth are making it much more difficult. This points to a genuine risk of a rating downgrade in the next two to three quarters.”

Monsoon Season

The monsoon, which accounts for more than 70 percent of the nation’s annual rainfall, was 17 percent below a 50-year average in the last two months, the weather bureau said Aug. 7. Farm minister Sharad Pawar has said India may be facing its worst drought since 1972, the Indian Express reported Aug. 5.

The yield on benchmark 10-year sovereign bonds jumped 14 basis points to 8.26 percent last week after the central bank on July 31 held its benchmark repurchase rate at 8 percent. The yield on the 8.15 percent notes due June 2022 fell two basis points, or 0.02 percentage point, to 8.12 percent in Mumbai today, according to the Reserve Bank’s trading system. Royal Bank of Scotland expects it to remain between 8 percent and 8.40 percent in the coming two quarters.

Governor Duvvuri Subbarao left interest rates unchanged for the second straight meeting, citing risks to prices from inadequate rains. He raised the RBI’s inflation forecast for the fiscal year to 7 percent from 6.5 percent, and slashed its economic growth estimate to 6.5 percent from 7.3 percent. The revised GDP prediction matched the previous year’s expansion, which was the slowest in nine years.

Revenue Shortfall

“The weak monsoon, through its impact on food production and prices, will make it harder for the government to narrow its food subsidy bill,” Taimur Baig, director of Asian economics at Deutsche Bank AG in Singapore, said in an Aug. 7 interview. “Chances of achieving the deficit target also decrease due to the increasing risk of an expenditure overshoot related to fuel subsidies and revenue shortfall due to weakening growth.”

Citigroup Inc. on Aug. 7 revised its forecast for India’s budget deficit to 5.9 percent from an earlier estimate of 5.5 percent, and cut its growth forecast to 5.4 percent from 6.4 percent. The economy may expand as little as 4.9 percent, the slowest pace since 2004, should drought conditions worsen, the bank said in a report.

Bond Risk

Standard & Poor’s lowered India’s sovereign credit outlook to negative from stable on April 25, saying the move reflects a one-in-three likelihood of a rating downgrade to junk status because of slower investment and economic growth. Fitch Ratings cut its outlook on June 18, citing limited progress in paring the budget deficit. Both companies rank India’s debt BBB-, the lowest investment grade.

Moody’s Investors Service, which has maintained a stable outlook on its Baa3 rating, said Aug. 2 that widespread power outages last month underscore India’s infrastructure gaps and have a “credit negative effect” on economic activity. The blackouts on July 30 and July 31 were India’s worst.

Bond risk has risen. Credit-default swaps on State Bank of India, which investors consider a proxy for the sovereign, have climbed 92 basis points in the past year to 312 in New York, according to data provider CMA. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to debt agreements.

The rupee, which declined 8.8 percent in the quarter through June in the worst performance in the region, rose 0.5 percent to 55.1375 per dollar today.

Subsidy Target

In its budget presented in March by the then Finance Minister Pranab Mukherjee, the government pledged to limit subsidies to 1.9 trillion rupees ($34 billion), or 2 percent of GDP, this fiscal year. In the previous year, handouts on fuel, foods and fertilizers overshot the government’s estimate by 51 percent to 2.16 trillion rupees, widening the budget deficit to 5.76 percent of GDP, compared with the target of 4.6 percent.

The government plans to boost debt sales by 12 percent to a record 5.69 trillion rupees this year to bridge the shortfall in its finances. It also proposes to raise funds by selling stakes in state-owned companies and auctioning mobile-phone licenses.

Finance Minister Palaniappan Chidambaram, making his first statement after taking charge of the ministry last week, said he will seek fiscal consolidation and work to revive investment.

‘Path of Consolidation’

“The economy is challenged by a number of factors,” Chidambaram said on Aug. 6. “Uppermost in my mind is the duty to regain the confidence of all stakeholders. We intend to unveil, shortly, a path of fiscal consolidation.”

The extra yield on India’s 10-year bonds over similar- maturity Treasuries widened 10 basis points this fiscal year to 643. Rupee-denominated sovereign notes returned 6 percent this year, trailing the 7.2 percent earned by Indonesian securities in Asia’s best performance, HSBC Holdings Plc indexes show.

“If the government doesn’t do anything about deficit and reforms in the next six months, you are going to see growth collapsing severely,” said Jahangir Aziz, the Washington-based chief economist at JPMorgan Chase & Co., who previously worked at the International Monetary Fund. “Things aren’t that bad that the ship can’t be turned around. But the ship needs to be turned around now.”

To contact the reporter on this story: Kartik Goyal in New Delhi at kgoyal@bloomberg.net

To contact the editors responsible for this story: Stephanie Phang at sphang@bloomberg.net; James Regan at jregan19@bloomberg.net

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