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Smooth Sail on Downgrade

Market seems to be at ease despite the sovereign downgrade to "junk status". Though days of stable interest are here to stay, but the downgrade should trigger some action from government.

A steady bond market faced the S&P' local currency downgrade with aplomb. Though the initial knee-jerk reaction was a sharp 20-30 paise fall in the bond prices. But it recovered soon, as the rationale cited for the downgrade proved to be a widely understood fact. The government's inability to contain the fiscal deficit, delayed disinvestment and government bailouts wasn't a surprise for the market participants. Even the finance secretary and RBI's remarks about improving economy health overshadowed the concerns over downgrade. The 10-year benchmark yield, after rising to an intra-day high of 7.20%, settled at last week's level of 7.18%.

The week also saw squeezed liquidity from the system on account of advance tax outflows. As a result, the bond yields as well as call rates did firm up initially. A fall in crude oil prices and government's borrowings schedule for rest of fiscal well below the budgeted levels brought stability.

As the ample purchases by public sector banks continued to mop-up greenback supplies, the domestic currency moved in tight leash of Rs 48.40-41/$. However as an immediate reaction to the downgrade, the rupee lost 7 paisa. But gained strength, as foreign institutional investors are not active players in debt markets.

S&P Downgrade: Substance and the Unsubstantiated
The S&P downgrade of India's long-term local currency debt to "junk" grade, is the second re-rating in past 12 months. Starting from BBB (Investment grade) in 1990, India's local currency debt is now reduced to BB (Speculative grade). This consistent downward revision has come despite the rapidly growing foreign exchange reserves. Today, the reserves are worth an year's import bill, up from just about a month in 1990. The consumer price index (CPI) is down to 4% from 11% in 1990. These numbers prompted widespread dismissal of the downgrade.

Perhaps, the only argument that holds ground is lack of fiscal prudence. The fiscal deficit is still at 6% against 8.3% of GDP in 1990-91. This indicates high level of unproductive expenditure and also proves to be a serious impediment to speedy reforms.

Outlook
Ignoring the downgrade, the bond market should have a stable week ahead. The government's planned borrowing of Rs 32,000 crore via dated securities may dent the prevailing liquidity in the medium term.