Hong Kong: Fitch Ratings has affirmed India’s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘BBB-‘. The issue ratings on India’s senior unsecured foreign and local currency bonds are also affirmed at ‘BBB-‘. The Outlooks on the Long-Term IDRs are Stable. The Country Ceiling is affirmed at ‘BBB-‘ and the Short-Term Foreign Currency IDR at ‘F3’.
Affirmation of India’s IDRs reflects the following key rating drivers:
According to Fitch, the Narendra Modi government’s broad-based structural reform agenda has brought dynamism back to the Indian economy, after a couple of years of limited progress on the structural front. Fitch expects the policy initiatives to bring the investment climate in India closer in line with its peers’. India’s relatively weak business environment and standards of governance, as well as widespread infrastructure bottlenecks, will not change overnight, but there is ample room for improvement. Translation of the reforms into higher real GDP growth depends on the actual implementation.
Following recent revisions to the GDP data, Fitch raised its forecasts for real GDP growth to 8.0% in the financial year ending 31 March 2016 (FY16) and 8.3% in FY17, compared with 7.4% GDP growth in FY15. Fitch’s earlier forecasts for FY16 and FY17 were 6.5% and 6.8%, respectively, based on the old series of data. The significantly higher official real GDP growth numbers after the revision by the Central Statistical Office suggest the data include more economic activity than is actually taking place. While the aim to produce GDP data more in line with international standards is commendable, these new GDP growth levels and the pick-up from as early as mid-2013 are difficult to reconcile with indicators and anecdotal evidence that show low investment levels, weak corporate balance sheets and a rise in banks’ non-performing loans.
While in recent years consumer price inflation has on average been high in India compared with peers, the greater focus by both the Reserve Bank of India (RBI) and the government on lowering inflation since 2014 represents a significant change from the past. The new IDRs based on inflation targeting seems to show the government and RBI’s strong resolve to structurally lower inflation. Both the RBI’s monetary policy and the government’s policies that affect food prices, including the setting of minimum support prices for agricultural products, will strongly influence whether the target will be reached.
Implementation of the government’s structural reform agenda and structurally lower inflation would improve the sovereign credit profile, as both would improve the investment climate and benefit real GDP growth. However, India’s sovereign ratings are constrained by limited improvement in India’s fiscal position, which is a longstanding key weakness.
India’s fiscal Achilles’ heel is evident in both the general budget deficit of 7.2% of GDP for the combined central and state governments, and gross general government debt of 64.7% of GDP, which are much higher than ‘BBB’ category medians of 2.7% of GDP and 41.4% of GDP, respectively. The central government seems to have met its fiscal deficit target of 4.1% of GDP for FY15 despite disappointing revenues. The budget, presented on 28 February 2015, also contained more plausible revenue targets for FY16 than in the previous budget. But the budget lacks initiatives to significantly increase government revenue. The government has chosen to increase capital expenditures, at the expense of fiscal consolidation. Greater tax devolution gives the states more discretionary spending power in areas for which they are responsible and are important for development, although the actual impact will depend on the administrative capacity in the individual states.
The external balances contain some strong elements, including a high level of foreign exchange reserves of USD341bn, or 6.7 months of current account receipts cover (compared with the ‘BBB’ peer median of 5.2 months), low net external debt of 3.3% of GDP (compared with a 7.9% ‘BBB’ peer median), and limited dependence of commodity exports. Moreover, the current account deficit has been contained by gold import curbs and lower international oil prices. These leave India less vulnerable than a number of its peers to renewed emerging market pressures, including from the coming normalisation of monetary policy in the U.S.
The Indian economy is less developed on a number of metrics than a number of its peers. Its ranking on the United Nations Human Development Index indicates relatively low basic human development, while average per capita income remains low at USD1,633 in 2014 compared with the ‘BBB’ range median of USD10,552.
The performance of the banking sector will likely remain weak for some time, although the pace of deterioration in asset quality has eased at a few large banks. State banks remain particularly affected, accounting for around 90% of the system’s stressed assets while suffering from sharply reduced earnings and weak capitalisation. The government’s ability to provide substantial financial support to the banking system in a potential crisis is limited given the already high government debt burden.
The Stable Outlook reflects Fitch’s view that upside and downside risks to the ratings are balanced. The main factors that individually or collectively could lead to positive rating action are:
- Fiscal consolidation or fiscal reforms that would cause the general government debt burden to fall more rapidly than expected
- An improved business environment resulting from implemented reforms and structurally lower inflation levels, which would support higher investment and real GDP growth
The main factors that individually or collectively could lead to negative rating action are:
- Deviation from the fiscal consolidation path, leading to persistence of the high public debt burden, or greater-than-expected deterioration in the banking sector’s asset quality that would prompt large-scale financial support from the sovereign
- Loose macroeconomic policy settings that cause a return of persistently high inflation levels and a widening current account deficit, which would increase the risk of external funding stress
- The global economy evolves broadly in line with the projections in Fitch’s Global Economic Outlook, and the eventual rise in U.S. interest rates does not prompt a general crisis in emerging markets
- Economic activity will not be seriously disrupted by materialising political risk, for instance related to social unrest, separatist movements, terrorism or insurgent groups like the Naxalites