Fitch Affirms India at 'BBB-'; Outlook Stable
KEY RATING DRIVERS
The affirmation of India's sovereign ratings balances a strong medium-term growth outlook and favourable external balances against a weak fiscal position and still-difficult business environment. However, the latter is likely to gradually improve with implementation and continued broadening of the government's structural reform agenda.
India exhibits one of the highest real GDP growth rates in the sovereigns space. Its five-year average growth is among the 10 highest of all rated sovereigns and the 7.6% real GDP growth in the financial year ended 31 March 2016 (FY16) exceeds the 'BBB' category median of 3.3%. Fitch forecasts real GDP growth to slightly accelerate to 7.7% in FY17 and 7.9% in FY18, resulting from an expected pick-up in consumption in both urban and rural areas after a civil-servant wage hike of 24% and the strong likelihood of stronger rainfall than in the previous two poor monsoon years. Policy rate cuts of 150bp in total since January 2015 may also contribute to growth, even though weak bank balance sheets continue to impair monetary transmission. At the same time, weak private investment indicates that the economy is still not firing on all cylinders.
Fitch also expects the government's continued structural reform push to support GDP growth in the medium term. Passage of the new Bankruptcy Code in both houses of parliament in May 2016 showed that big-ticket reforms are possible in India, even though the government's proposal for a Goods and Services Tax has thus far not passed in the Upper House (Rajya Sabha). Those reforms that only require executive approval continue to be rolled out and some legislative reforms are being pursued at the state level. A resulting improvement in the business environment is also indicated by swelling foreign direct investment inflows, although India still ranks lowest among sovereigns in the 'BBB' category in the World Bank's Ease of Doing Business index, and this is not likely to change anytime soon.
Inflation has substantially come down in the past two years, even though it started to pick up again in recent months to 5.8% in June 2016 on the back of food price pressures. Fitch expects inflation to remain below the five-year average of 7.8%, which is high compared with the 'BBB' median of 3.3%, given the change to an inflation targeting framework in February 2015. To what extent the new monetary framework will represent a true regime shift will become clearer in the period ahead, when a new Reserve Bank of India governor will take over from Raghuram Rajan, the Monetary Policy Committee will be established and perhaps more clarity will exist on the life span of the current inflation target (4% +/- 2pp).
Weak fiscal balances, India's Achilles' heel for years, continue to constrain its ratings. The central government's consolidation efforts, illustrated by meeting its deficit target of 3.9% for FY16 and sticking to its 3.5% target for FY17, strengthen its fiscal credibility. The government continues to face a difficult trade-off between its desire to crowd-in private investment by spurring public capex and to further consolidate, especially since a public wage increase of 24% has recently been approved. The review of the Fiscal Responsibility and Budget Management Act leads to short-term uncertainty on the medium-term fiscal framework, but might also provide an opportunity if it brings the fiscal parameters closer in line with India's peers. This was happening in the years until FY08, just before the Global Financial Crisis. Fitch expects general government debt to reach 69.4% of GDP in FY17 and the general government deficit to slightly fall to 6.8% of GDP, which compares unfavourable with 'BBB' peer medians of 40.6% and 2.6% respectively.
The banking sector's non-performing loans (NPLs) rose to 7.6% of total assets in FY16 from 4.6% in FY15, mainly resulting from stricter implementation of standards. The NPLs are most prevalent in public-sector banks, highlighting significant sovereign contingent liabilities. It is not clear if the government's budgeted IDR700bn capital injection into banks between FY16 and FY19 will be sufficient. Fitch estimates the banking system needs around USD90bn (INR6trn, or 4% of GDP in FY17) of capital, while many public-sector banks are likely to find it difficult to access new capital from non-government sources.
India's relatively strong external balances make the country less vulnerable to external shocks than many of its peers. The foreign reserves buffer is solid at 8.3 months of current external payments, while gross and net external debt levels also compare well. A narrower current account and a pick-up in FDI caused India's basic balance to turn positive in FY16. India is not immune to emerging-market turmoil, but should generally be able to weather such jitters relatively well. India is less vulnerable to a severe slowdown scenario in China, as India's exports to China comprise only 3.5% of total exports and its more domestically based economy is not part of the Asian supply chain. The medium-term Brexit impact on the real economy seems limited given that India's exports to both the UK and the rest of the EU have fallen to 3.4% and 13.6% respectively of total exports.
The Indian economy is less developed on a number of metrics than many of its peers. Average per capita GDP remains low at USD1,647 compared with the 'BBB' range median of USD9,358, while India's ranking on the United Nations Human Development Index indicates relatively low basic human development. Governance also continues to be weak, as illustrated by a low score for the World Bank governance indicator (41th percentile versus the 'BBB' median of 57nd percentile) and Transparency International's corruption index (76th of 168). Nonetheless, press reports seem to suggest that high-level scams are less prevalent than in the past.
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.
RATING SENSITIVITIES
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 initiatives that would cause the general government debt burden to fall more rapidly than expected in the medium term
- An improved business environment resulting from implemented reforms and persistently contained inflation, which would support higher private investment and real GDP growth
The main factors that individually or collectively could lead to negative rating action are:
- Further deviation of the already high public-debt burden from the peer median, which may be caused by stalling fiscal consolidation or greater-than-expected deterioration in the banking sector's asset quality that would prompt large-scale sovereign financial support
- 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
KEY ASSUMPTIONS
- The global economy performs broadly in line with Fitch's latest Global Economic Outlook
- Economic activity will not be seriously disrupted in case of materialising political risk, for instance related to social unrest, separatist movements, terrorism or insurgent groups like the Naxalites
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