India's medium term fiscal outlook key for rating action: Thomas Rookmaaker

Fitch Ratings expect India's economic activity to contract by 5% in FY21 due to the strict lockdown measures imposed, before rebounding by 9.5% in FY22

As Fitch Ratings revises outlook on India’s ratings to negative from stable, its Director (sovereign ratings) THOMAS ROOKMAAKER tells Indivjal Dhasmana that though the country's economic growth would bounce back in FY22, it is yet to be seen whether medium-term growth outlook of 6-7 per cent is achievable. He talks on fiscal metrics, government debt market, India-China tensions, and signals to investors due to actions by rating agencies. Edited excerpts:

Fitch Ratings expects India’s economy to contract 5 per cent in FY21 due to the Covid-19 pandemic. But when normalcy returns, you expect the recovery to be quite sharp. Then why was the outlook on India’s ratings put at negative?

Indeed, we expect economic activity to contract by 5 per cent in FY21 from the strict lockdown measures imposed, before rebounding by 9.5 per cent in FY22. This rebound will mainly be driven by a low-base effect. Our forecasts are subject to considerable uncertainty and downside risk due to the evolution of the virus, and continued acceleration in the number of new Covid-19 cases as the lockdown is gradually being eased. 

Under our rating methodology we rate through economic cycles, but it remains to be seen what impact the crisis may have on India’s medium-term economic growth and whether sustained growth rates of 6 per cent to 7 per cent as previously estimated, will be achievable, especially if financial sector weaknesses persist.

You have said the government has shown restraint on expenditure. Then why did you take this action on outlook?

Fiscal metrics have significantly deteriorated due to the impact of the severe growth slowdown on revenue, the fiscal deficit and public sector debt ratios. We expect general government debt to jump to 84.5 per cent of GDP in FY21 from an estimated 71.0 per cent of GDP in FY20. This is significantly higher than the median of 42.2 per cent of GDP for the ‘BBB’ category in 2019, to which FY20 corresponds and 52.6 per cent for 2020. The medium-term fiscal outlook is of particular importance from a rating perspective, but is subject to large uncertainty and will depend on the level of GDP growth and the government’s policy intentions going forward.

Does the outlook mean that there are more chances of downgrade of India’s ratings than earlier?

Outlooks indicate the direction a rating is likely to move over a one- to two-year period.  They reflect financial or other trends that have not yet reached or been sustained the level that would cause a rating action, but which may do so if such trends continue. A negative outlook signals a negative trend.

The rating agency said the government intends to open up more to foreign capital in the next few years as a source of deficit financing. Won’t it lead to further volatility in markets?

Opening up to foreign capital markets might expose the economy to overseas volatility, while by deepening the capital market it could also smooth volatility. Its overall effect remains to be seen and will depend on foreign investors’ appetite for India’s government debt.

Your commentary said a stronger focus by the ruling BJP on its Hindu nationalist agenda risks becoming a distraction for economic reform implementation. But, this government announced a slew of reforms recently. Do you think these would not be implemented because of the very nature of this government?

The government has announced a number of structural reforms to strengthen GDP growth over the medium term. Reforms to improve the efficiency of agricultural supply chains and the intention to privatise state-owned enterprises could be transformative, but this depends on the details and the implementation. A rise in social or political tensions could become a distraction.

Fitch said geopolitical risk related to long-standing border issues with India’s neighbours was highlighted again by recently intensified tensions with China. Was that also factored in your rating outlook action?

The revision of the outlook to Negative was related to the impact of the coronavirus pandemic on economic growth and the fiscal metrics, rather than the recent tensions at the border. But we will continue to monitor geopolitical risk. In some countries it does affect the rating, such as Korea and Taiwan.

Moody’s recently downgraded India’s ratings. Fitch and S&P did not do so. All the three rating agencies have the lowest investment grade for India. But Fitch and Moody’s have negative outlook, while S&P has stable. Do these different actions not give conflicting signals to investors in India?

At Fitch we have our independent views. Investors are free to choose, and may find differing perspectives of value in their investment decisions.