A rating downgrade after 14 years?

The Indian economy is going through one of its toughest tests at the moment. Despite successive rate hikes in the past, inflation has not come down to the levels that the central bank had anticipated. Meanwhile, GDP growth has slowed down and monsoons have not really taken off leading to droughts in many parts of the country. As if that was not enough, the industrial production contracted by 1.8% in June and has taken many by surprise. This is the third time that the IIP has contracted in the last 4 months and was largely on account of the slump in the manufacturing sector. Further in this, the non-durables output growth contracted 1% meaning that high inflation has played a role in reducing consumption.

As a result, with not much happening on the reforms front and the economic woes only piling on, there is the possibility of India facing a credit downgrade. So far, international ratings agencies have not lowered India's credit rating (which is a notch above investment grade) for nearly 14 years. However, some of them had cut their ratings outlook in recent months following the decline in the country's economic indicators. Indeed, the last ratings downgrade took place after the 1998 nuclear tests.

Ratings of credit agencies could be taken with a pinch of salt. The lack of credibility displayed by major ratings agencies during the global financial crisis is ample proof of that. But that does not take away the fact that India does have a serious problem on its hands. While policy reforms and removing supply constraints would be the obvious answer, it is easier said than done since there are so many difficulties on the political front. The RBI has already done its bit. So all eyes will now be on the latest Finance Minister Mr Chidambaram and how he chooses to tackle these issues. Although it is apparent that some bold steps will be needed to be taken, it is unlikely that the current government will do anything radical that will hurt the sentiments of its voters.