Reality check about Moody's ratings upgrade and Why investors should avoid IPOs

Moody's Ratings Upgrade - a reality check

"Moody's Investors Service upgraded its ratings on India's sovereign bonds for the first time in nearly 14 years on Friday (Nov 17 '17), saying continued progress on economic and institutional reform will boost the country's growth potential.

The agency said it was lifting India's rating to Baa2 from Baa3 and changed its rating outlook to stable from positive as risks to India's credit profile were broadly balanced."

The Finance Minister and various government functionaries wasted no time in appearing on various TV channels to tom-tom the 'achievement' as an endorsement of the NDA government's financial reforms and fiscal prudence by an 'internationally reputed ratings organisation'.

Now, here is the reality check (from a Reuter's article):

"Moody's upgrade, its first since January 2004, moves India's rating to the second lowest level of investment grade. Standard & Poor's has kept India at the lowest investment grade just above junk status for a decade and Fitch Ratings for one year longer."

There is no guarantee that S&P or Fitch will follow Moody's in upgrading India's sovereign bonds ratings. In other words, as of now, two out of three 'internationally reputed ratings organisations' have kept India's sovereign bonds ratings just above junk status.

The ratings upgrade by Moody's is definitely a positive sign - but not a huge deal just yet. Expecting FDI to pour in may be a bit premature. However, FIIs did join DIIs as net buyers of equities on Friday (Nov 17). The rally in the stock market is likely to continue next week. 

Why investors should avoid IPOs

A recent article in bloombergquint.com mentioned that 32 companies have cumulatively raised Rs 50,000 Crores from IPOs so far this year - the highest on record. "Promoters and (existing) shareholders walked away with the bulk of the gains by offloading stakes."

"Shares of 23 of the 32 companies that have gone public this year either declined or gave low returns since the close on the first day of trading." 

20 companies have provided negative returns from the closing level on the first day of listing till Nov 15. 3 companies have gained less than 5%. 5 companies have gained between 10% & 49%. The balance 4 companies - Avenue Supermarts, PSP Projects, Apex Frozen Foods and Shankara Building Products - have gained between 72% & 132%.

If you have been thinking about jumping on to the IPO bandwagon in the hope of making gains on listing, think again. The odds are not in your favour. 

Does India deserve the ratings downgrade by S&P?

The answer to the question will depend on who is answering it! The Finance Minister and a Deputy Governor of RBI brushed the S&P ratings downgrade aside as if it was a fly buzzing around while you were trying to enjoy your breakfast. An irritation at best, but of no particular significance.

Adrian Mowat of JP Morgan had a different view. He didn’t expect that FII or FDI inflows would be affected by much. The GAAR provisions, if applied retrospectively, would cause much greater damage to overseas investor sentiments.

However, those companies that had borrowed large sums of money through the FCCB route during the hey-days of 2006-2007 may be in a spot of bother. Most of their share prices are trading at a small percentage of the soaring heights they reached during the final stages of the previous bull market. Converting the FCCBs to equity at current lower prices may not be an option because the promoters may lose control.

The other option is to repay the amounts borrowed. This is where the problem may lie. Since several companies don’t have the cash to repay their borrowings, they have been trying to negotiate a rollover of their loans with the lenders. The S&P downgrade has put paid to that option.

There is a third option – which the unscrupulous Ruias of Essar group availed. Default on the loans, and buy time while the matter meanders through the courts. A few companies may have no alternative but to default. Those who value their reputation may be forced to sell some of their assets to raise the cash.

Why did S&P downgrade India’s credit rating in the first place? And was the downgrade fair? There should be no doubt in any one’s mind that India’s fiscal and current account deficit situation is in danger of spinning out of control. Faulty policies that placed politics ahead of economics, and inability to introduce tough and unpopular legislation has caused a financial mess and an unmanageable rate of inflation.

So, S&P’s downgrade should not have come as a great surprise. In fact, it may just be the kick on the backside needed to propel the moribund financial reforms process back to life. But was the downgrade fair? Aren’t countries like Spain and Ireland - which have much more precarious debt-to-GDP ratios than India’s - enjoying better credit ratings? Is it because they are ‘developed countries’ while India is still an ‘emerging economy’?

Moody’s came up with a credit rating that was more optimistic than S&P’s. That calmed some of the initial shock that the stock market experienced. But S&P’s downgrade should be treated as a wake-up call by the Finance Minister. Blaming the opposition and coalition partners won’t get us anywhere. It is time for precipitate action. The stock market is awaiting bold policy actions to resume its up trend. It will also help accelerate the government’s disinvestment policy and fill some of the fiscal gap.