Saturday, June 11, 2005

The fuss of Standard and Poors India rating downgrade

The lowering of India's long term sovereign currency rating from BBB- to BB+ by Standard and Poor's opens up a can of worms for India's financial position . S&P said that the perception towards India's long term rating was below par. S&P also downgraded India's short-term local currency rating to "B" from the earlier "A-3".What does all these mean ?.Well, before all these one must know what is the Standard and Poor's rating all about and what does it signify. Standard and Poors is an organization which provides ratings and opinions about the capital markets.It mainly intends to quantify the creditworthiness of the players of the capital markets .S&P remains unbiased and analytical in disclosing the facts that make or break the trading trends across the world's capital markets. They provide the world's most reliable investment data,financial analysis ,creditworthiness ratings to all the potential
investors.The McGraw hill company traces its origin to the 142Yr old Standard's and Poor's . As on now Standard and Poor's operate in about 18 countries with 7 affiliate around the globe (including one in India).They comprise of over a 1000 analysts some of who are popular and respected investors and economists.

None of the S &P's rating signifies any kind of advice to buy or sell a particular investment tool either at a national or at an individual level. A respected outcome of the merger between Standard Statistics and Poor's Publishing, today S&P is the most respected and accepted
provider of financial statistics and data to the investors of interest.

Be it short term investment tools like equity or any kind of mutual fund that is aggressive or long term alternatives like government paper,corporate bonds,S&P rating has always been taken seriously ,if that particular investment option has been rated. Standard and Poor's has the most observed and commented United States portfolio index of S&P500 along with over $1.5trillion worth assets that have been indexed by various other indices . S&P has also been setting standards at various levels for financial sectors around the globe and also sectors like
Oil,construction ,software that have a close affiliation to the financial sector and the performance with in at the global level .
These set standards have also helped investors to be more focused in their investment decisions and accurately portray their 'risk-appetite' .S&P has been rating Bond transactions, holding companies and insurance.They have also evolved tracking mechanisms for the indices.
Standard and Poor's have been independent in their ratings ,they have no affiliation with any Govt. agents what so ever .The rating of S&P have been signifying the creditworthiness of the borrower This rating is devised on the information that is made available to them by the investors ,the borrower and the external 'prevailing' economical conditions.
S&P's , both the long-term and short term ratings is the quantification of the capability of the borrower to repay in the specified timeline and the notation just adds value to it.Alike the Indian credit rating firm 'Crisil' , a 'AAA' rating is the strongest which speaks the financial prowess of the borrower .A 'D' signifies the non-investment grade .Most of the S&P's ratings include a Plus or the minus sign providing the relative position of that which is rated with respect to other
rated instruments in that category. Hence a positive suffix would be that the instrument is likely to increase in creditworthiness and a minus means the opposite .

Given the fact that S&P's ratings are based on only those parameters that invoke investor confidence in transactions, the ratings reflects the position of the borrower in a rather absolute sense .All ratings are assigned considering all the aspects that define the creditworthiness - legal , past trends and other quantitative and qualitative measures .
The fundamentals are what that are used in quantifying the creditworthiness .
The ratings are assigned only after a thorough study of all the factors that determine the financial credibility of the 'client' , like the industry of concern, the fundamentals that drive the industry , the economic developments that can influence the creditworthiness of the country .
All the financial details (Public and non public) are considered in confidence and a team assigned to 'client' is headed by an analyst .The financial behavior of the company in terms of the kind of investments they consider to maintain liquidity and long-term stability in the company is considered .Also ,the management policies that the company adapts ,the
technological changes and the company'sstrategies to match up to them are also taken while calibrating. The issue does not end after a rating is done It is also reviewed as and when the conditions that effect the same are reviewed. A credit watch listing is prepared that is to be tracked and the analysis for the re-rating is undertaken .The 'client' keeps S&P informed about all the policy changes and changes in the way financial statements are prepared.

What happened in India?
Standard and Poor's had downgraded the India's Long-term local currency from BBB- to BB+ which in colloquial sense was equal to 'Junk' .They had also downgraded the short-term rating from A-3 to B .It was expected to effect the long term borrowing substantially but certainly not the foreign direct investment in India .With 3% of India's borrowing being comprised by foreign debt and 98% of the borrowings were done from within India.

To reduce the total borrowings government of India granted total freedom to carryon with pre-payments. Also that the fiscal deficit was more contained at the time of S&P downgrading as compared to the same time last year.

The Rating Guide
- AAA : Financially strong and would be able to meet commitments .
- AA : Very strong to meet financial commitments
- A : can meet financial commitments ,but is sensitive to economic upheavals
- BBB : Can meet the commitments but a little more sensitive to external factors
- BBB- : May or may not meet the commitments, almost of non investment quality
- BB : Would eventually become sensitive to extrinsic factors
- B : Extremly sensitive to external adversaries but currently can meet all the commitments
- CCC : dependent only on similar domain business opportunities
- CC : Highly vulnerable to all the forces
- D : Defaulted payments
- Investment Grade : AAA,AA,A and BBB
- Subject of speculation : BB,B,CC and C

Source : The official website The first two quarters also witnessed a good growth in exports, hence a good balance of payment position and an ability to make accelerated repayments to service the external debt.Also the Forex reserves were at a comfortable $62Bn .
Standard and Poor's has attributed the rate cut towards the increasing debt burden and also hoped further cuts if the reforms goes on in the current pace.

But, one school of thought voiced that the India's forex reserves was a record in itself if the economic and political upheavals were taken into consideration and also the fact that inflation was low. One aspect everyone was confident was that ,in order to increase the creditworthiness it was imperative to initiate faster reforms and quicker disinvestment .

The foreign currency rating still remains stable for India as far as S&P is concerned.
The fiscal deficit of India is actually a culmination of the state fiscal deficits .The downgrade would not effect the overseas business as the amount of foreign funds in Indian government paper was minimal and also that the rating on 8 Indian companies were stable(See box).

What about the markets?
The markets reacted by dropping 1.5% but gained later,the tech heavy equity dropped .But there was a fair amount of optimism considering the optimism of government being under pressure to disinvest smaller PSUs .The sensitive index of Mumbai was down by 0.9% settling at 3014 .

S&Ps eight Indian companies
- Indian Oil Corporation Limited(IOCL)
- National Thermal Power Corporation(NTPC)
- Tata Engineering and Locomotive Company(TELCO)
- Tata Power
- Larsen and Toubro Ltd
- Indian Railway Finance corporation
- Reliance Industires
- Power Finance corporation