Moody’s Rating upgrade: Positive for Long term

Moody’s upgraded India’s sovereign rating to Baa2 from Baa3 with Stable Outlook.

What do ratings mean?

Credit Rating reflects financial strength of a country when it raises money from the debt markets. Ratings vary from Aaa to D. ‘AAA’ rated asset/Sovereign is considered the safest. Safest assets/sovereign can raise loan at the cheapest rate.

All countries are rated in relation to each other. Any rating equal to or above Baa3 (S&P BBB-) is considered as “investment grade”. Ratings below that are called “Junk” or Non-investment worthy.

How does ratings upgrade help us?

India was rated Baa3 (S&P BBB-) which was just one notch above Junk grade. This was due to poor fiscal policy, low tax base, populist budgets, etc. This ratings upgrade is a big positive. India is still a developing country. It requires large capital to build infrastructure and generate employment. Upgrade in rating can attract more investors to Indian debt market. Also, the interest cost for the government would be lower to the tune of ~0.25-0.5% annually.

Savings in interest outgo for the government could lead to increase in budget to enhance infra and employment. This would lead to increase in income and hence positive on housing and consumer discretionary.

The decline in interest rates will drive down overall cost of capital for the country. We believe that current bond prices and equity valuations already capture potential decline in cost of capital. So net effect on their prices will be minimal in the short term.

Talking about multiplier effects of ratings Upgrade, we are of opinion that infrastructure like Power, Roads, Telecom & Oil&Gas would benefit from fall in interest rates. Apart from that, financial companies like Banks and NBFCs, which raise funds from debentures or invest in government securities, are likely to benefit.

We have become positive on India’s macro scenario due to the government’s focus on reforms like Infra and bank recapitalization. This rating upgrade will help implementation of these reforms. Long term prospects have improved drastically from what we were seeing three years ago.

However, we are still wary of market valuations. We will not go over overboard in buying stocks at current valuations. We will pick stocks selectively when they trade at reasonable valuations. Paying a high price may earn some additional returns in short term. But over medium term, the returns could be low vs the risk of losing money.

We are currently evaluating companies that are likely to benefit from reforms and ratings upgrade. We will recommend stocks if risk reward is in our favour. We are expecting valuation to inch upwards for Cement, Infrastructure and capital goods companies. However, we may not be able to buy any one of them today due to stretched valuations. But we always see some or the other stock coming down due to bad quarterly results thanks to market’s obsession with short term.

We continue to believe that stocks in Pharmaceuticals and IT are relatively cheap and worth considering as part of your portfolio. You may add slowly as they go down and as time passes. One may have an allocation to bluechip companies in the respective sector. You may also add top companies in power generation and transmission companies as they trade at reasonable valuations with good dividend yield.

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