Do changes in sovereign rating matter?

| Updated on: Apr 28, 2012

S&P's downgrade of India's long-term credit rating to negative from stable has sent a ripple of worry.

But do such rating change really affect capital flows? And do such actions impact India Inc's ability to borrow abroad?

Experience suggests that it might. We analysed foreign portfolio and direct investment inflows in 2006-07, when S&P last revised its India rating. On that occasion, S&P had raised the country's credit rating to ‘investment' grade (from BB+ to BBB-) for the first time.

An analysis of data between 2006 and 2008 shows that flows of FII (foreign institutional investment), FDI (foreign direct investment) and ECB (external commercial borrowings) spiked in the month immediately following the change, that is, in February 2007.

More important, the average FII, FDI and ECB inflows, studied on a monthly basis, remained high in the 12 months following the upgrade.

Between February 2007 and 2008, the average FII inflows increased by 90 per cent while average the FDI flows rose 32 per cent, compared with the same period in 2006-07. Overseas borrowings (ECBs) increased more than 40 per cent.

This revision, however, did not make any significant change to the structural trend in the data. It may also not be correct to attribute the surge entirely to the rating change. It is quite possible that the gush in foreign capital flows or borrowings in 2007 was also due to a booming economy.

The key difference between 2007 and now is that the latest change is only to the rating ‘outlook'. In 2006-07, the action entailed a change in India's credit rating from BB+ to BBB-, while S&P has now maintained the BBB- rating.

But the analysis does show that the Government should not be taking its fiscal deficit and public debt situation lightly, as rating changes can have a bearing on the economy.


Published on November 15, 2017

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