Fitch affirms India's rating at 'BBB-' with stable outlook

Fitch Ratings has affirmed India's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) as well as Country Ceiling at 'BBB-'. The outlook on the Long-Term IDRs are stable.

A ‘BBB‘rating indicates that expectations of default risk are currently low. The capacity for payment of financial commitments is considered adequate but adverse business or economic conditions are more likely to impair this capacity.

The ‘-‘ modifier appended to the rating denotes relatively lower status within major rating categories. The Stable Outlook reflects Fitch's view that upside and downside risks to the ratings are balanced.

The global credit rating agency said the issue ratings on India's senior unsecured foreign- and local-currency bonds are also affirmed at 'BBB-'. The Short-Term Foreign-Currency IDR rating has been affirmed at 'F3' (the intrinsic capacity for timely payment of financial commitments is adequate.)

Key rating drivers

Fitch's affirmation of India's sovereign ratings and Stable Outlook balances a strong medium-term GDP growth outlook and favourable external finances, including a strong foreign reserves buffer, with a high government debt burden and weak structural features, including a difficult - but improving - business environment.

India's positive GDP growth outlook stands out globally. Fitch forecasts India's real GDP growth to accelerate to 7.5 per cent in the fiscal year ending March 31, 2016 (FY16) and 8.0 per cent in FY17, from 7.3 per cent in FY15, supported by the government's beefed-up capex spending and gradual implementation of a broad-based structural reform agenda.

The Reserve Bank of India's (RBI) policy rate cuts of 125 basis points in total in 2015 are also likely to contribute to higher GDP growth, even though monetary transmission is impaired by relatively weak banking sector balance sheets.

The agency, in a statement, said India's real GDP growth averaged 6.7 per cent over the past five years, which is considerably higher than the 'BBB' range median of 3.0 per cent, and it remains so even if the uplift in growth resulting from the GDP data revision by the Central Statistical Office in February 2015 is discounted.

It observed that “The government continues to steadily roll out its ambitious structural reform agenda, as illustrated in recent months by the announcement of new reforms that will likely improve the business environment, including changes in the foreign direct investment (FDI) regime.

“It has so far turned out difficult for the government to garner the required support in the Upper House (Rajya Sabha) for some big ticket reforms, including a national Goods and Services Tax, but those reforms that only require executive approval continue to be implemented and legislative reforms can still be pursued at the state level.”

India's relatively weak business environment and standards of governance are gradually improving as a result of the pursued reforms, but obstacles faced by investors, including infrastructure bottlenecks, have not been reduced overnight, Fitch said.

World Bank ranking

India moved up four places in the World Bank's Ease of Doing Business rankings in 2015, but is still the worst-performing of all 'BBB' range sovereigns at 130th out of 189 countries. Translation of structural reforms into improved indicators and higher real GDP growth depends on actual implementation.

India's sovereign ratings, according to the agency, continue to be constrained by limited improvement in its fiscal position. The seventh Pay Commission's recommendation of a 23.6 per cent increase in remuneration for central government employees raises doubts about the feasibility of the medium-term consolidation path without any new revenue-generating measures.

Fitch expects a general government fiscal deficit, including both the central government and the states, of 6.7 per cent in FY16, more than double the 'BBB' peer median of 2.8 per cent. Further, it expects the general government debt burden to rise to 68.8 per cent of GDP in FY16 from 66.8 per cent in FY15, one of the highest of 'BBB' range sovereigns and far off the 'BBB' category median of 42.8 per cent of GDP.

The increase largely results from state governments taking part of the power distribution companies' debt onto their own balance sheets, a reform which overall is considered credit positive, as it is accompanied by reinforced incentives for states to improve the functioning of these companies.

Inflation

Inflation in India averaged 7.9 per cent over the past five years, comparing unfavourably with the 'BBB' peer median of 3.3 per cent. However, a structural reduction in the consumer price inflation level, likely supported by the monetary policy framework changes in February 2015, strengthens India's sovereign credit profile, the agency said.

The RBI's monetary policy track record is reinforced by inflation turning out broadly in line with its targeted glide path. Fitch noted that generally favourable international oil and food price developments allowed the RBI to loosen monetary policy without, as it seemed, risking a breach of the inflation targets in the near future. The government's decision to limit minimum support price rises for agricultural products helped to keep inflation under control.

India is not immune to external shocks, but seems less vulnerable than many of its peers. “External vulnerabilities have reduced substantially in the past two years, particularly its narrowed current-account deficit, which Fitch expects to reach 1.1 per cent in FY16 compared with the 'BBB' median of 5.6 per cent, and a build-up of reserves to 7.7 months of current external payments,” the agency explained.

The external balances are also likely to be strengthened by a continued rise in FDI inflows driven by strong reform and growth momentum. India is also less vulnerable than many peers to a potential severe slowdown in China, as bilateral trade between the two countries is limited (3.6 per cent of India's exports in FY15 and 7.8 per cent if Hong Kong is included) and India's more domestically based economy is not part of the Asian supply chain.

The Indian economy is less developed on a number of metrics than its peers. Its ranking on the United Nations Human Development Index indicates relatively low basic human development, while the average per capita income remaining low at $1,669 in 2015 compared with the 'BBB' range median of $9,145.

Public sector banks form a contingent liability for the government's finances in the years ahead. The banking sector's non-performing loans, which Fitch expects to reach 4.9 per cent of total assets in FY16, are likely to hamper banks' ability to internally generate capital at a time when they will require capital to transition towards Basel III by FY19.

Fitch said it remains to be seen if the government's planned capital infusion of Rs 70,000 crore into the public sector banks will be adequate in light of supervisory norms and weak equity valuations.

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