Any erosion in credit quality risks scaring investors who’re already net sellers of Indian bonds and stocks this year, which can push the rupee toward a record low and stoke inflation. Moreover, a downgrade could tarnish Modi’s reputation — already hit by the abrupt demonetisation move — before a slew of state elections starting on 4 February.
“The government has limited avenues available to stimulate the economy,” said Neelkanth Mishra, managing director for equity research at Credit Suisse SA in Mumbai. At best finance minister Arun Jaitley could scrounge up about Rs2.5 trillion ($37 billion), an “insignificant” amount for the $2 trillion economy that saw 86% of its currency invalidated in November and is estimated to face cash shortages through May.
A worsening of public finances risks spurring price pressures and deny the inflation-targeting central bank space to lower interest rates, belying economists’ predictions of a cut to 6% from 6.25% this quarter. If the Reserve Bank of India holds, the yield on the 10-year sovereign bond will rise to 7% in 2017 from about 6.5% and worsen outflows, said Arvind Chari, head of fixed income and alternatives at Mumbai-based brokerage Quantum Advisors Pvt.
