Overseas borrowing costs of Indian companies all set to increase

By Vipin Agnihotri

Lucknow, India: If the Indian government fails to meet its deficit reduction targets, the overseas borrowing costs of Indian companies could increase over the next two years. You may ask: Why is it so? This is because failure to meet deficit reduction targets can adversely impact the sovereign credit rating of the country.

On the other hand, if the rating worsens, there will be fewer takers in overseas markets for Indian bonds and international lenders will charge more from Indian firms looking to raise money. “The rating models used by international lenders factor in sovereign ratings, and a drop in the ratings would have an impact (on the rating of Indian companies and the interest rate they would have to pay), pointed out Shailesh Nigam, partner and head, Dreamz advisory, an audit firm.

And that is where, India’s Fiscal Responsibility and Budget Management (FRBM) Act, 2003, come into the fray to shrink revenue deficit, the difference between the government’s revenue receipts and revenue (or operational) expenditure, to zero by March 31, 2009. When The India Street analyzed the whole issue, it came into light that in the financial year leading to the deadline, 2008-09, India and the government will likely be in election mode - the present government assumed office in 2004 for a five-year term. I do not expect the government to be in a position to control expenditure in an election year.

It is worthwhile remembering that Finance minister P. Chidambaram has already said in public that he expects revenue deficit to be 1.5 per cent of GDP at the completion of the current financial year (2007-08), a minimization of 50 basis points compared with the last financial year (2006-07). The pivotal factor here is that if the government has to meet the targets set by the FRBM Act, it would have to minimize its revenue deficit by a further 150 basis points. Interestingly, in his Budget speech in February, Chidambaram had said the government was on course to achieve this.”

Meeting this target had a bigger impact on India’s sovereign rating than is usually understood,” pointed out highly placed source at Finance ministry. “It was seen as a sign that the entire political spectrum was in favour of fiscal prudence and any deviation would affect India’s credibility,” pointed out Sunil Dang, Editor of The Day After Magazine. Though, some experts do not see cause for alarm. “I don’t see a major danger at this point,” said Azim Khan, a renowned economist at rating agency when asked about the possibility of the government falling short of its target.

Up till now, the government’s attempt to squeeze revenue deficit has succeeded primarily on account of the sharp growth in tax revenue. In my opinion, maintaining momentum of revenue is critical for meeting FRBM targets. Statistic wise, revenue growth has been spurred by an economy that grew by 9.2 per cent and 9 per cent in the matter of two years. Initial signs are that India’s GDP will grow by over 8 per cent in 2007-08 and 2008-09.

In the last few years, the combination of strong economic growth, introduction of the FRBM Act, and better government finances have encouraged international credit rating agencies to push India’s sovereign rating into investment grade. For example, Standard & Poor’s Rating Services raised India’s rating to investment grade in January after a gap of 15 years.