The rating agencies have never been kind to India. Through the nineties when we were growing at more than 6%, we were regarded as below investment grade. It took several years of growth of 8-9% for S&P to upgrade us to investment grade in 2007. Today, we are BBB-, just one notch above below-investment grade, the same as Iceland (which went through a frightful financial crisis recently). We are two notches below Ireland (yet to recover from a banking crisis) and Spain, which has just received a bailout. Beats me.
Now, S&P has warned India of a possible downgrade further ahead unless it gets its act together. India's external debt to GDP of 3.4% is among the lowest in the world. We have not defaulted on our foreign obligations all these years and are unlikely to do so even if growth slows to 6% in the next year or two years. We are among the few nations whose debt to GDP ratio has declined in recent years. What, then, is the basis for S&P's warning?
I visited the S&P website to understand their rating methodology for sovereigns. They use a combination of political, economic, external, fiscal and monetary scores. Even if one parameter, the external score, looks good,your rating can go down if the other scores worsen. Let's say that an unwieldy coalition looks likely to assume power in Delhi. The political score would worsen and you could get a downgrade- so I understand their methodology.
In India's case, this approach looks suspect because the link between a worsening of various scores and default probability is weak. Politics could get more contentious; reforms may grind to a halt; the monetary authorities may not have room to lower interest rates. But this does not increase the probability of default on foreign obligations because external debt is so low.
This is not the only argument I would make. I do not believe that the link between political regimes or even economic regimes and growth in India is all that strong. If the global situation improves, the present set of reforms could easily give us 7.5-8% growth; if the global situation remains bad, some of the reforms people are talking about will not make a big difference.
More in my ET column, S&P, India Inc overdoing gloom.