India Resilient even as Fitch downgrades US Ratings!

Last week, Fitch Ratings downgraded the United States of America's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'AA+' from 'AAA'. This downgrade comes a long time after the last downgrade carried out by Standard & Poor’s (S&P), in 2011, for the first time in 70 years.

Why did Fitch downgrade US’s rating?

The rating downgrade of the US has been executed on the account of the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to 'AA' and 'AAA' rated peers over the last two decades, that has manifested in repeated debt limit standoffs and last-minute resolutions.

How is US placed in the wake of this downgrade?

Global growth momentum is expected to become increasingly sluggish with a stubborn core inflation and lagged impact of fast paced monetary tightening done over last one and a half year. In US, while headline inflation fell to 3% in June 2023, core Personal Consumption Expenditure inflation – the Fed's Key Price Index, remained high at 4.1% year-over-year. This could delay cuts in the Federal Funds Rate, as the Fed’s goal is to bring inflation down to its target level of 2%.

Further, as per Fitch, the general Government deficit is expected to rise to 6.3% of GDP in 2023, from 3.7% in 2022, reflecting cyclically weaker federal revenues, new spending initiatives and a higher interest burden. As a result, the supply of treasury bills to fund the deficit could cause the yields to remain elevated.

The immediate impact of this downgrades wasn’t significant, with US yields not moving more than 10 basis points the day after the downgrade. (1 basis point is one hundredth of a percentage). This suggests that the overall market continue to view US treasuries to be a safe haven asset class.

Does this affect dollar’s reserve currency status? In the past few months, there has been renewed interest in dollar’s status as the world’s reserve currency. Some economies have been dealing in non-USD currencies, bringing spotlight to the persistence of its dominance. If one looks at the share of USD in the central banks’ forex reserves over the years, it shows a declining trend with share falling from 66% 2015 to 59% in 2023.
 

Source: International Monetary Fund
 

Various factors still support USD’s status as the ‘World’s Reserve Currency’, such as the significant dependence of the current global financial and trade system, relative stability and rule of law vs other global governments, etc. However, recent trends on this front are certainly worth watching out for.

How is India impacted?

The US rating downgrade is not likely to have any significant impact on India, as our economy is placed well structurally. As India moves into Amritkaal, some of our strengths include, a favourable macroeconomic environment, robust demographics, resurgence of manufacturing, pick up in private capex, thrust on infrastructure capex, and significant potential for increasing consumption.

The Reserve Bank of India (RBI) has been proactive in countering inflation, making timely interventions in the form of higher repo and reverse repo rates. In addition to this, over the past few months, the movement of the change in India's 10-year G-Sec Yields vs US 10-year Treasury Yields have become increasingly divergent, signalling the different trajectories of inflation that the market expects in the two countries.
 

Source : Bloomberg, As on August 4, 2023
 

Conclusion

To sum it up, the fundamental strength from domestic economy bodes well for the Indian equity markets. In addition, the healthy corporate profitability and growth-supportive policies make us positive on equities over the medium-to-long-term. However, sharp slowdown in global growth, escalation of geopolitical tensions and re-acceleration in inflation globally or locally are material near-term risks.

Sources: Fitch, Bloomberg, IMF, RBI Bulletin, and other publicly available information

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