Fitch Ratings has revised the outlook on India's long-term foreign-currency issuer default rating (IDR) to 'Stable', from 'Negative', and has affirmed the IDR at 'BBB-'.
It said, “The outlook revision reflects our view that downside risks to medium-term growth have diminished due to India's rapid economic recovery and easing financial sector weaknesses, despite near-term headwinds from the global commodity price shock. Fitch expects robust growth relative to peers to support credit metrics in line with the current rating.”
Fitch further said, “High nominal GDP growth has facilitated a near-term reduction in the debt-to-GDP ratio, but public finances remain a credit weakness with the debt ratio broadly stabilising, based on our expectation of persistent large deficits. The rating also balances India's external resilience from solid foreign-exchange reserve buffers against some lagging structural indicators.”
Key Highlights
Recovery puts the economy on stronger footing: "India's economy continues to see a solid recovery from the Covid-19 pandemic shock. GDP recovered by 8.7 percent in the fiscal year ended March 2022 (FY22), and we forecast GDP growth to remain robust at 7.8 percent in FY23 compared with the 3.4 percent 'BBB' median," said the rating agency.
However, Fitch said this is a downward revision from our 8.5 percent forecast in March as the inflationary impacts of the global commodity price shock are dampening some of the positive growth momenta.
Solid medium-term growth prospects: India's strong medium-term growth outlook relative to peers is a key supporting factor for the rating and will sustain a gradual improvement in credit metrics.
"We forecast growth of around 7 percent between FY24 and FY27, underpinned by the government's infrastructure push, reform agenda and easing pressures in the financial sector. Nevertheless, there are challenges to this forecast, given the uneven nature of the economic recovery and implementation risks for infrastructure spending and reforms," said the rating agency.
Financial-sector pressures easing: Conditions in the financial sector were a key growth impediment before the pandemic, but have improved in recent years, which should facilitate better credit allocation and investment in the medium term.
Banks' capital sufficiency will be important in determining their ability to provide more credit, even as regulatory forbearance has given them time to rebuild capital buffers. Potential asset-quality deterioration from the pandemic shock appears manageable, but there are risks as forbearance measures unwind amid heightened global macroeconomic uncertainty.
High deflator improves debt ratio: India's debt-to-GDP ratio benefits in the near term from a sharp acceleration in nominal GDP growth.
"We forecast the debt-to-GDP ratio to drop to 83 percent in FY23 from a peak of 87.6 percent in FY21, but it remains high compared to the 56 percent peer median. Beyond FY23, however, our expectations of only a modest narrowing of the fiscal deficit and rising sovereign borrowing costs will push the debt ratio up slightly to around 84 percent by FY27, even under an assumption of nominal GDP growth of around 10.5 percent," Fitch said.
India's IDRs also reflect the following key rating drivers:
Commodity Prices Exacerbate Fiscal Pressures: Fitch expects India's general government fiscal deficit to remain broadly stable at 10.5 percent of GDP (excluding divestment) in FY23, compared to 10.7 percent in FY22.
In its budget, the central government prioritised capital expenditure over more substantial fiscal consolidation.
"We forecast that the fuel excise-duty cuts and increased subsidies (about 0.8 percent of GDP) announced in May to offset higher commodity prices for consumers, will push the central government deficit to 6.8 percent of GDP compared to the budget's 6.4 percent target, despite robust revenue growth," said the rating firm.
Fiscal consolidation to remain gradual: Fitch Ratings expects the general government fiscal deficit to narrow at a modest pace over the next several years, reaching 8.9 percent of GDP by FY25.
In its February budget, the central government retained its 4.5 percent of GDP FY26 deficit target, but little clarity was given on measures to achieve it. In our view, achieving this target could prove challenging, particularly as revenue and GDP have already returned to pre-pandemic levels, said the rating agency.
High-interest payments/revenue of 26 percent of GDP in FY22 ('BBB' median: 7 percent) constrains fiscal flexibility, particularly in the context of rising sovereign bond yields. "We forecast the aggregate state deficit to gradually return to its pre-pandemic norm of 3 percent of GDP over the next several years from 3.8 percent in FY22, Fitch Ratings said.
Domestic borrowing needs remain high: Risks associated with India's high public debt are partly offset by the country's ability to finance its deficits domestically, which is a strength relative to most 'BBB' peers.
Foreign-currency government debt comprises only 5 percent of total debt (BBB median: 33 percent) and only 2 percent of government securities are held by non-residents. However, sustained large fiscal financing needs are likely to contribute to a crowding out of private-sector lending and higher borrowing costs.
Inflationary pressures rise: Fitch expects inflation to remain elevated in FY23 at 6.9 percent (BBB median: 4.9 percent), due to the sharp rise in global commodity prices and underlying demand pressures.
The Reserve Bank of India (RBI) lifted its policy repo rate by 90bp to 4.90 percent in just over a month, signalling its growing concerns that inflation could exceed its 2-6 percent target band for a sustained period.
"We forecast the RBI to continue to withdraw liquidity and raise rates, with the repo rate reaching 6.15 percent by FY24," said the ratings firm.
Resilient external finances: External risks remain relatively well-contained, despite the sharp rise in oil prices.
Fitch expects the current account deficit to rise to 3.1 percent of GDP in FY23 from 1.5 percent in FY22 on the back of a higher oil import bill, while resilient exports mitigate the deterioration.
Large foreign-exchange buffers, which reached $607 billion by FYE22 (9 months of imports), will help the country manage financial market volatility emanating from global monetary-policy tightening. Reserves may moderate somewhat to $563 billion by FYE23 (7.5 months of imports).
ESG - governance: India has an ESG Relevance Score (RS) of '5' for political stability and rights, and an ESG RS of '5[+]' for the rule of law, institutional and regulatory quality and control of corruption.
Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. India has a medium WBGI ranking at 47.6 reflecting a recent track record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.
Disclaimer: This article is based on a Fitch Ratings report. Views and recommendations made above are those of the rating agency and not of MintGenie.
