India’s sovereign ratings balance: Fitch points to weak fiscal position and difficult business environment
India’s Long-Term Foreign- and Local-Currency Issuer Default Ratings is affirmed at ‘BBB-‘. The Outlooks are Stable. The Country Ceiling is also affirmed at ‘BBB-‘ and the Short-Term Foreign- and Local-Currency IDRs are affirmed at ‘F3’.
Hong Kong: On India’s sovereign ratings balance, Fitch Ratings has affirmed a strong medium-term growth outlook and favourable external balances with a weak fiscal position and difficult business environment.
Fitch has also predicted that India’s business environment is likely to gradually improve with the implementation and continued broadening of the government’s structural reform agenda.
According to Fitch, India’s positive GDP growth outlook stands out among peers. Real GDP growth averaged 6.9% over the five years to end-March 2017 (FY17), considerably higher than the ‘BBB’ range median of 3.2% and remaining so even if the uplift in growth resulting from the GDP data revision by the Central Statistical Office in February 2015 is discounted.
Fitch forecasts India’s real GDP growth to accelerate to 7.7% in FY17 and FY18, from 7.1% in FY16. The agency expects structural reforms to increase growth, along with higher real disposable income supported by the implementation of the 7th Pay Commission recommendations and a monsoon with average rainfall expected by the Indian Meteorological Department.
Fitch goes on to underscore that the Indian government has been consistently rolling out its ambitious reform agenda for almost three years and remains committed to continued reforms. A rise in foreign direct investment (FDI) inflows to USD55.5 billion in FY16, from USD36.0 billion in FY14, shows that India is becoming a more attractive destination for foreign investors. The government has also hinted at further reforms to support FDI inflows in its latest Budget. The goods and services tax (GST) and the Insolvency and Bankruptcy Code represent two important legislative reforms that have now passed parliament. The impact of the reform programme on investment and real GDP growth will depend on how it is implemented and the extent to which the government continues its strong drive to improve the still-weak business environment.
The authorities’ focus on reining in inflation is starting to bear fruit and might represent a structural shift away from the high inflation rates of the past. The authorities remain committed and institutions appear in place to ensure a structural fall in consumer price inflation from the 8.0% average of the previous decade. The Reserve Bank of India (RBI) is building a solid monetary policy record, broadly meeting intermediate targets of the glide path towards the medium-term inflation target of 4% +/- 2%, while easing policy in the previous two years where possible. At the same time, the framework has not yet been seriously tested in an environment of unfavourable international oil and food prices. Keeping prices under control also requires government support, for example, by limiting minimum support price rises for agricultural products.
Weak public finances continue to constrain India’s ratings, with a high general government debt burden of 67.9% of GDP (‘BBB’ median: 40.9%) and wide fiscal balance of -6.6% of GDP (‘BBB’ median: -2.7%), as estimated by Fitch for FY17. However, there are some early indications that fiscal policy might become more focussed on bringing down debt.
An official committee reviewing the Fiscal Responsibility and Budget Management Act has recommended lowering government debt to 60% of GDP. It remains uncertain if the government will commit to the target suggested by the committee, but in his February 2017 budget speech, the finance minister explicitly recognised the low number of direct taxpayers, stating that India is “largely a tax non-compliant society”, which is a significant change in rhetoric. The central government’s FY18 budget also continues its gradual consolidation efforts irrespective of the difficult trade-off with the desire to spur infrastructure spending.
Significant contingent liabilities for the sovereign continue to emanate from public sector banks. The banking sector’s non-performing loans (NPLs) problem is well recognised by authorities, but continues to linger. Fitch expects NPLs to rise to 9.7% of total loans by end-FY17, from 4.6% in FY15, due mainly to stricter implementation of standards. NPLs are most prevalent in public-sector banks, which are likely to find it difficult to access new capital from non-government sources. It is not likely that the government’s budgeted INR700 billion (USD11 billion or 0.5% of GDP) capital injection into banks between FY16 and FY19 will be sufficient. Fitch estimates the banking system, including private sector banks, needs capital of around INR6 trillion (USD90 billion or 3.2% of GDP in FY19).
India is not immune to external shocks, but the country’s strong external finances make it less vulnerable than many of its peers. A narrower current account and pick-up in FDI caused India’s basic balance to turn positive in FY16. Fitch expects the current-account balance to narrow to -0.9% in FY17 (‘BBB’ median: -1.5%) and foreign reserves to build up to 8.4 months of current external payments (‘BBB’ median: 6.6 months). India is also less vulnerable to trade shocks due to its more domestically-based economy, which is not part of the Asian supply chain, and lower commodity export dependence compared with some peers.
India’s economy is less developed on a number of structural metrics than many of its peers. Average per capita GDP remains low, at USD1,714, compared with the ‘BBB’ range median of USD9,701. Governance standards also remain weak, as illustrated by a low score for the World Bank governance indicator (46th percentile versus the ‘BBB’ median of 58th percentile).
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns India a score equivalent to a rating of ‘BBB-‘ on the Long-term foreign-currency IDR scale. Fitch’s sovereign rating committee did not adjust the output from the SRM to arrive at the final long-term foreign-currency IDR.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a long-term foreign-currency IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The Stable Outlook reflects Fitch’s assessment that upside and downside risks to the ratings are broadly balanced.
The main factors that, individually or collectively, could trigger positive rating action are:
– Implementation of fiscal initiatives that increase the likelihood of a decline in general government debt over the medium-term
– An improved business environment resulting from reform implementation and contained inflation, which would support higher private investment and real GDP growth
The main factors that could trigger negative rating action are:
– A rise in the public-debt burden, which may be caused by stalling fiscal consolidation or greater-than-Fitch-expected deterioration in the banking sector’s asset quality that could prompt large-scale sovereign financial support
– Loose macroeconomic policy settings that cause a return of persistently high inflation and widening current-account deficits, which would increase the risk of external funding stress