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May 26, 1998


S&P's downgrade send forex markets into a tizzy

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Nikhil Faleiro in Bombay

When the United States imposed sanctions on India under the Glenn-Symington Amendments for violating the non-proliferation code, the talk of tough action against the Indian economy seemed more akin to mere rhetoric. Everyone brushed aside the thought of the India being the victim of US economic aggression. The situation seemed even better after CEOs of leading US corporations such as Boeing, Enron, Bank of New York, and Citibank assured Indian investors and corporate heads alike that the sanctions are a mere formality and nothing concrete would materialise.

Yet, despite all the bravado, uncertainty did prevail since no one was really clear on how badly the sanctions would affect the economy. This was reflected in the wide fluctuation in the stock markets. And for the whole of last week, the rupee began to float in the markets, under intense pressure on rumours that Standard and Poor, the New York-based rating agency, was going to downgrade India's sovereign rating.

The Indian rupee finally cracked on Monday, when it touched a low of Rs 41.20-22, though it ended higher at Rs 40.94-97. On Tuesday, the rupee ended at Rs 41.14-17.

What prompted the rupee's sudden fall was decision by Standard and Poor to revise the foreign currency rating outlook on six Indian companies from stable to negative. The six companies are among India's best known: Power Finance Corporation Ltd, National Thermal Power Corporation Ltd, the Tata Electric Companies, Reliance Industries Ltd, Larsen and Toubro, and the Tata Engineering and Locomotive Company.

While everyone expected the country's rating to be lowered, the fact that six large corporates were affected hurt the markets tremendously. Says the vice-president of a leading financial institute, "When a country's rating is lowered, it is expected that the companies trading overseas will have the opportunity to raise finance abroad and bring in money. But when a company's rating is lowered, then it is serious business."

According to Standard and Poor, the revision of India's credit rating reflects the erosion of India's financial position following the imposition of sanctions by the US and other countries. The country has ample foreign currency reserves of about $ 28 billion, or twice the stock of short-term debt. However, if it is forced to absorb the near-term impact of sanctions, India's balance of payments could come under increased strain in the medium term from reduced inflows of both official and private capital.

Within minutes of S&P lowering the rating, the rupee Monday plunged from Rs 40.75 to a new low of Rs 41.22 on renewed fears of a decline in dollar inflows. Corporates panicked over the possible shortage of dollars, combined with the absence of the State Bank of India, the country's largest commercial bank and a major player in the forex market, the rupee fell for only the second time after the sanctions were imposed. However, the rupee recovered to end yesterday at Rs 40.94-97.

Tuesday was no better. With corporates purchasing dollars in large quantities, the rupee continued to fall for the second consecutive day. The rupee fell ended at Rs 41.14-17, after touching a low of Rs 41.21, while the State Bank of India stayed away. However, according to a dealer, "The SBI was absent from the market due to a technical fault, and by the time the fault was rectified, it was too late and the rupee had reached a new low."

S&P's downgrade also hit the money markets, and this is a greater source of worry as it will push up the cost of international funds much more than expected.

Corporates, confused with the S&P downgrading, are already looking around for new avenues to fund their projects. K Kannan, chairman, Bank of Baroda, put it succinctly, "Why make a company suffer if its fundamentals are good? The sanctions have nothing to do with my balance sheet. This is unfair and confuses the whole issue," he said.

While the money markets are still waiting for the big bomb to drop, vis-a-vis the US-led sanctions, brokers and dealers are bracing themselves for another deluge on the market. Watch this space.

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