Impact on India’s external sector, growth seen marginal

Impact on India’s external sector, growth seen marginal

Fitch’s decision to downgrade the US government’s credit rating by a notch from the top level is unlikely to take the sheen off the US treasuries as the safest, liquid investment option for global finance capital, as market sentiments will continue to be supported by the dollar’s reserve status, economists and trade analysts said.

Since the US will try and adjust the exchange value of its currency to offset any marginal impact of the credit graders’ action in the forex market, any appreciation of the emerging marketing currencies like the Indian rupee may be marginal and short-lived, they feel.

Of late, there has been a rush for overseas borrowings among Indian companies — the June quarter saw ECBs signed by Indian companies jump to $12 billion, nearly three times the year ago level, and the bulk of the funds is apparently being raised for investment activities.

“In the short term, there could be some disturbance (for Indian markets). However, in the medium term to long term, this downgrade will not impact our growth. India has already downgraded growth in FY24 (to 6-6.5% from 7.2% in FY23), because the slowdown in advanced countries will impact our goods and services exports,” N R Bhanumurthy, vice chancellor at Bengaluru-based BASE University said.

Some independent observers had flagged the possibility of India’s merchandise exports in the current financial year to be lower than last year’s, even before the Fitch decision. Moreover, the momentum in services exports has slowed too, with just 5% growth in April-June quarter, compared with a 27% surge witnessed in the last financial year.

For sure, the Fitch move was not entirely unexpected, as it had warned two months ago the US credit rating was under threat, citing the uncertainty that prevailed over the country’s debt limit.

The possibility of a prolonged shake-up is also minimised by the fact that a similar rating downgrade of the US by S&P in 2011 (it has since persisted), only led to higher inflows into US treasuries amid an equity sell-off.

The immediate reaction of the bond markets to the Fitch move was one of relative poise. “Equities and bonds will revert to normal in next few sessions. Currency impact will also correct though we need to watch for a week or so. Investment flows will not move out due to this (Fitch’s rating) change,” Madan Sabnavis, chief economist at Bank of Baroda, said.

According to V K Vijayakumar, chief investment strategist at Geojit Financial Services, “The US 10-year bond yield spiking above 4% and the dollar index rising to 102 are near-term negative for emerging markets. But it is important to note that the downgrade doesn’t say anything that the market didn’t already know. So, any negative knee-jerk reaction will be short-lived.”

In fact, in recent weeks, the global equity markets have been rising, amid heightened expectations of a soft landing of the US economy. The rating agency’s move doesn’t alter that perception. The dominant narrative of the Indian economy has already factored in the external headwinds.

Sabnavis noted that the dollar index could fall in next couple of sessions, before reverting to normal. “The crux is time taken for reversion, (if it is short), the impact should be minimal.”

“In the current financial year, India’s external accounts will be under pressure, not only because of the US, but also the European Union. Many countries in Europe are already in a technical recession. So, we will have this showing up on the exports side,” Bhanumurthy added. According him, though there could be some implications on capital flows into the country, since the rupee-dollar equation will get quickly adjusted, the impact will not be much.

Since August 1 this fiscal year, net FPI inflows into Indian equity markets have been strong at $17.8 billion, while debt markets saw net inflows of $2.2 billion. “FPI flows are largely dependent on domestic factors. There could be a slight impact sentimentally, but there seems to be no reason to worry as long as local factors are favourable,” said Pankaj Pandey, head of research at ICICI Direct.

Ajay Sahai, director general & chief executive officer at FIEO noted that the downgrade of the US government’s credit rating was not entirely unexpected, given its rising fiscal deficit and recent political stand-off over increasing the debt limit. “The downgrade may raise cost of funds in the US and may influence demand, but no immediate impact of this on Indian exports is expected. After all, the impact on demand, if it occurs, will be for all exporting countries,” he said.

Sahai, however, added that in medium to long-term, the downgrade may lead to dollar weakening against other currencies. Thus, he said, would help Indian traders push foreign trade in local currencies as well as the settlement of trade in rupees, of which early strides are being made, and policy impetus has lately become stronger.

India Ratings chief economist DK Pant noted that India’s capital flows are unlikely to be impacted significantly by the US rating downgrade. “These (capital inflows) will be more impacted by the growth and inflation trajectory of Indian economy. However, if this (Fitch move) translates into a general tighter financial conditions across the globe, the impact could be significant,” Pant said.

“Even the US bond market hasn’t reacted much (to Fitch move). Any impact on flows to emerging markets is unlikely, unless there’s a major movement in the interest rate or currency,” said U R Bhat, co-founder and director of Alphaniti Fintech.

Ajay Srivastava, founder at Global Trade Research Initiative, maintained that it is too early to asesses the impact of downgrade on Indian exports. The US is the biggest market for India’s goods exports, with shipments of $78.31 billion in FY23, and India has a trade surplus with the world’s largest economy (imports from the US were $50.24 billion in FY23, up 16% on year.” Exports to the US have declined in Q1FY24 o $18.65 billion, from $21.65 billion in the year ago period.

Justifying its decision to lower the credit rating for the US from AAA to AA+, Fitch said the US finances will likely deteriorate over the next three years, given the tax cuts, new spending initiatives, economic shocks and repeated political gridlock. It also cited a “steady deterioration” in governance over the last 20 years, and added that the world’s largest economy might slip into a “mild recession” later this year.

Treasury Secretary Janet Yellen called the rating agency’s decision “arbitrary” and based on “outdated data.” She highlighted that the US economy has recently shown signs of resilience and the debt limit was ultimately lifted.