FE View: Insecure sovereign

Moody's downgrade shows exposure to govt is now injurious to health of institutions.

Written by Fe Bureau | New Delhi | Published: May 14, 2012 3:33 pm

The downgrade of Life Insurance Corporation (LIC) and three Indian private sector banks by Moody’s on Monday basically shows why exposure to the Indian government is now injurious to the financial health of institutions. The common thread in both set of downgrades map the ratings of the Indian sovereign.

The downgrade establishes two things. The quality of the fiscal performance of the sovereign is now the ceiling for any Indian company’s rating. This rather stems from the Indian government’s declared position at multilateral forums that its ability to add muscle to the financial institutions was not being appreciated adequately. The second impact is that banks or financial institutions cannot substitute investment in government treasury as an alternative to providing more credit or selling insurance cover to the people. It only makes them more vulnerable to a sovereign downgrade.

The ratings review makes borrowing from abroad costly for the three banks. The review for LIC makes it clear that it is now a de facto government department. By paying policy holders a cumulative rate of return of only 5%,it has consistently under paid them. Turns out that the principal too is now becoming somewhat insecure.

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