S&P's warning comes a couple of months after they had changed India's outlook to negative in the month of April.
"Slowing GDP growth and political roadblocks to economic policymaking are just some of the factors pushing up the risk that India could lose its investment-grade rating," the ratings agency said in a statement issued Monday on a report dated June 8.
"Failure to advance with more liberalization might reduce India's long-term growth potential and thus hurt its sovereign rating," the report said.
"To my mind, there has been no change in the economic conditions since then, except that the GDP growth number came out a tad disappointing compared to the government's initial forecast," said Madan Sabnavis, Chief Economist at CARE Ratings.
India's sovereign rating is BBB-, the lowest investment grade rating, and in April S&P lowered its outlook on the rating for Asia's third-largest economy to negative from stable.
The rupee slipped to 55.55 to the dollar from 55.45 earlier after the S&P statement.
The S&P warning against India is clearly a negative sign for the markets and it could hurt foreign fund flows at least for the short term, according to analysts.
The market has taken an initial shock-beating. The larger question is, will the rating downgrade effect capital flows?
Sabnavis of CARE Ratings is of the view that it will not affect capital flows to India entirely. FDI continues to come in good numbers and last year India received a total amount of $ 36 billion - the highest ever in a year, where investment is based more on a long-term view.
"FII flows will be whimsical and will be looking at the markets with circumspection. These funds are more likely to track policy movements in the country when taking a decision and under the present economic conditions could be influenced by these ratings," added Sabnavis.
We have collected views from various experts on the impact of S&P warning on markets:
Vaibhav Agrawal, VP - Banking, Research at Angel Broking
June is likely to remain a choppy month for Indian markets as more than the S&P downgrade it is developments in the euro zone that are going to determine the direction.
We would not give too much weightage to the S&P downgrade - they have been downgrading almost the entire world, including the US and while there are concerns globally as well as in case of India, but in our view, India remains one of the better placed economies globally to invest in.
The rupee is structurally vulnerable due to our high current account deficit. So that was a macro-adjustment that was required. It is good that the RBI did not interfere with the market forces in letting the rupee depreciate to an extent.
A. K. Prabhakar, Senior Vice President - Equity Research at Anand Rathi
S&P statement is very negative for Indian market as this would spook already weak foreign flows, which has improved in last few days on account of positive global cues. Rating downgrade would keep pension funds and other long term funds away from India.
Market failed to cross 5125 level on the Nifty and below 4950 levels things will become negative. Also, Nifty was unable to sustain levels above its 200-DMA which is placed at 5066.
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