Fitch revises India's outlook to stable; affirms 'BBB-' rating

Credit rating agency Fitch Ratings has revised India's outlook to stable from negative and affirmed its long-term foreign- and local-currency issuer default ratings (IDRs) at 'BBB-'.

The agency has also affirmed the country ceiling at 'BBB-' and the short-term foreign-currency IDR at 'F3'.

Fitch said the revision of the outlook to stable has been based on the measures taken by the government to contain budget deficit as also the commitments made and the progress, albeit limited, made in addressing some of the structural impediments to investments.

Fitch, however, did not consider the continuing weakness of the Indian currency, which has plummeted to record lows against the US dollar.

The agency said the outlook revision and the affirmation of India's investment-grade ratings reflected the government's success in containing the upward pressure on the central government budget deficit in the face of a weaker-than-expected economy.

The central government's fiscal deficit was 4.9 per cent of GDP in FY13 (year ended March 2013), compared with 5.7 per cent in FY12 against Fitch's forecast of close to 6 per cent when it placed India's ratings on negative outlook in June 2012.

Fitch expects the government to broadly meet its FY'14 budget deficit target of 4.8 per cent of GDP (including privatisation receipts) and to gradually reduce the high level of public debt over the medium-term.

The government gross debt (GGD) as a share of GDP was at 64 per cent in FY'13, significantly higher than both the 'BB' and 'BBB' peer rating group medians of 33 per cent and 40 per cent, respectively.

However, it is substantially below the level of 79 per cent of GDP when Fitch upgraded India to 'BBB-' in 2006, the agency noted.

Moreover, Fitch noted the government's move to address structural factors that have weakened the investment climate, notably regulatory uncertainty, delays in government approvals of investment projects and supply bottlenecks, as in the case of power and mining sectors.

Fitch expects the establishment of a Cabinet Committee on Investment (CCI) to help fast-track infrastructure-related projects.

The Indian government has also made it easier for foreign-direct investment to access a range of industries, Fitch noted, adding, however, that the investment climate could benefit from further reforms, such as the new land acquisition bill, some liberalisation of insurance and pension provision and public procurement, which are pending parliamentary approval.

Addressing the structural issues in the power and mining sectors would further boost investor confidence, Fitch said.

Measures taken by the Reserve bank of India (RBI) has helped reduce inflationary pressures on the economy. However, Fitch said the recent weakness of the exchange rate might, however, complicate policy management and limit the scope for further cuts in RBI policy rates.

Fitch expects the economy to recover after real GDP grew just 5 per cent in FY13 against the 6.2 per cent growth recorded in FY'12. India's economic recovery, however, is likely to remain slow until a healthier investment climate is created, which helps lift potential growth again. Fitch is forecasting only a modest recovery with real GDP expected to expand 5.7 per cent and 6.5 per cent in FY'14 and FY'15, respectively.

The profitability and capital position of the banking sector will remain under pressure as asset quality continues to gradually deteriorate. Nonetheless, Fitch does not view the banking sector as a material risk to macro-financial stability, nor to public finances in terms of the crystallisation of large contingent liabilities.

Despite deterioration in the current account deficit, in part due to an increase in gold imports, Fitch considers India's overall external position to be a relative rating strength. Foreign debt is moderate and RBI's international reserves, which stood at $288 billion at the end of May, provide a cushion to absorb adverse external shocks.

India's investment-grade rating is also underpinned by high domestic savings rates that limit the reliance on foreign savings for private investment and fiscal funding, as well as by a relative long maturity of government debt issued in its own currency. While Fitch has revised down its assumption regarding potential growth to 6-7 per cent from 8-9 per cent, it remains one of the most dynamic and diversified economies in the world.

Fitch has suggested the following as the main factors that individually, or collectively, could trigger positive rating action:

• Sustained fiscal consolidation or fiscal reforms, which lead to a sharp decline in the GGD-to-GDP ratio; and
• An acceleration in economic reforms that leads to a material improvement in potential growth rate consistent with stable consumer price inflation and external balance.

The main factors that individually, or collectively, could trigger negative rating action include:

• Larger-than-projected budget deficits leading to a steady rise in the GGGD-to-GDP ratio;
• A further decline in India's potential growth rate or a sustained rise in inflation;
• Greater-than-expected deterioration in the banking sector's asset quality that prompts large-scale financial support from the sovereign; and
• A sustained deterioration in the current account deficit, which leads to heavy external funding stress.

Fitch's medium-term fiscal projections assume:

• A gradual reduction in the central government budget deficit and medium-term growth rate of between 6 per cent and 7 per cent per annum;
• No sustained rise in commodity prices, particularly in crude oil, and a gradual recovery in the global economy - Crude oil is forecast to average $105 and $100 per barrel in 2013 and 2014 respectively, while the global economy is projected to expand 2.2 per cent and 2.8 per cent in 2013 and 2014 respectively (vs. 2 per cent in 2012); and
• No sharp and sustained escalation in global and financial volatility over the forecast period, for example an event with an impact on the scale of the collapse of Lehman Brothers.