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Credit rating woes: Indian markets to take a hit

| 8/15/2011 5:02 PM Monday

August 2011 has just witnessed a once-in-a-lifetime moment – the downgrading of the United States of America’s long-term sovereign credit rating from ‘AAA’ to ‘AA+’. The US had been holding onto the highest long-term sovereign credit rating of ‘AAA’ since 1917. Standard & Poor’s concurs that it will be increasingly challenging to bridge the gulf between political parties over fiscal policy, making it difficult for the Congress and the Administration to be able to leverage their agreement earlier this week into a broader fiscal consolidation plan that stabilises the government’s debt dynamics any time soon.

The downgrade has renewed fears of a double-dip recession, accompanied by constant squabbling in policy formulation, creating more uncertainty for investors across asset classes.

While the downgrade will have limited impact on the Indian economy, it is likely to be felt by the equity markets due to an increase in global risk perception of emerging markets like India on account of its current account deficit. While the developed markets are struggling to put growth back on track, India, on the other hand, has been going through a tightening cycle of its own. Upsides in the Indian equity markets have been restricted, as the RBI has increased rates 11 times over the past 18 months, in its attempt to fight inflation.

In this scenario, it makes ample sense to stay clear of companies and sectors which have a propensity to guzzle cash often, leading to huge piles of debt to be serviced from operations.

The infrastructure sector, mainly road builders and power generators, that also have sizeable debt, can be considered at basement bargain prices. But it is important to stick to leaders in that space, and have a mighty heart to slug it out for the long haul, if need be. IT, textiles, gems and jewellery have had their day in the sun, and are likely to cool their heels for sometime. However, FMCG or consumer durables are likely to keep the cash registers ringing, making investors happy, even a bit giddy due to the vertigo of higher valuations – here, the party is likely to continue for some more time.

The silver lining to the Indian markets is the drop in international commodity prices, mainly oil, that can lead to the inflationary monster being reined. This can lead to a pause in inflation and a reduction in the rates, manna from heaven for the investment cycle to pick up.
It did not require S&P to tell the world that the US is no longer worthy of an ‘AAA’ rating. That was just an official endorsement of conventional market wisdom. It may lead to some sell-off in the near term, as some funds have to make the technical adjustment of selling their non ‘AAA’ investments and the global risk appetite going up, leading to initial withdrawal from the emerging markets. In a few weeks, things will settle down. Things will boil down again to what matters the most for equity investors – businesses that can generate sustainable growth in profits. Nothing more, nothing less.

 

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