KEY RATING DRIVERS
India's rating balances a strong medium-term growth outlook and favourable external balances with weak fiscal finances and some lagging structural factors, including governance standards and a still-difficult, but improving, business environment.
A favourable economic growth outlook continues to support India's credit profile, even though real GDP growth fell to 6.6% in the fiscal year ended 31 March 2018 (FY18) according to official preliminary estimates, from 7.1% in FY17. Fitch forecasts growth to rebound to 7.3% in FY19 and 7.5% in FY20, as a temporary drag will fade from the withdrawal of large-denomination bank notes in November 2016 and the introduction of a Goods and Services Tax (GST) in July 2017. The GST is an important reform, however, and is likely to support growth in the medium term once teething issues dissipate. India's five-year average real GDP growth of 7.1% is the highest in the APAC region and among 'BBB' range peers. Growth has the potential to remain high for a substantial period of time, as convergence with more developed economies can be expected. Per capita GDP is the lowest among 'BBB' range peers (3.2% of the U.S. level versus the 'BBB' median of 17.3%) and continued structural reform implementation should enhance productivity. India has the highest medium-term growth potential among the largest emerging markets, according to a recent Fitch analysis.
The Reserve Bank of India (RBI) is building a solid monetary policy record, as consumer price inflation has been well within the target range of 4% +/- 2% since the inception of the Monetary Policy Committee in October 2016. Fitch expects inflation to average close to 4.9% in FY19, still almost double the 'BBB' range median of 2.5% for 2018. We expect the RBI to start raising its policy repo rate next year from 6% currently as growth gains further traction. Monetary tightening could be brought forward if recent government policies push up inflation expectations, including the decision to increase minimum support prices for agricultural goods to 1.5 times the cost of production and increased customs duties on certain products, including electronics, textiles and auto parts.
India's relatively strong external buffers and the comparatively closed nature of its economy make the country less vulnerable to external shocks than many of its peers. Foreign reserves equal 8.3 months of current external payments ('BBB' peer median: 7.0 months), while gross and net external debt levels also compare well. However, net FDI inflows fell to USD23.7 billion in the first three quarters of FY18 from USD30.6 billion a year earlier, and, unlike in many of India's peers, are now insufficient to cover a widening current-account deficit. Fitch expects the basic balance to widen to -1.3% of GDP in FY20 from -0.5% of GDP in FY18 ('BBB' peer median +1.2% of GDP). The government has continued to gradually open the economy to foreign investors, including allowing 100% FDI in the single-brand retail through the automatic route since January 2018. Such measures may facilitate a recovery in FDI, particularly if combined with further investment climate reforms. India rose 30 places in the World Bank's Ease of Doing Business ranking in 2017 and has ample potential to improve its position further, as it still ranks below both the 'BBB' and 'BB' medians.
Weak fiscal balances, the Achilles' heel in India's credit profile, continue to constrain its ratings. General government debt amounted to 69% of GDP in FY18 ('BBB' median: 41% of GDP), while fiscal slippage of 0.3% of GDP in both FY18 and FY19 relative to the government's own budget targets of last year, implies a general government deficit of 7.1% of GDP ('BBB' median: 2.1%). The central government currently aims to gradually reduce its own fiscal deficit from 3.5% in FY18, but would not hit the 3.0% of GDP ceiling of the Fiscal Responsibility and Budget Management (FRBM) Act before March 2021, which is well beyond its current electoral term. The government has reasserted its longer-term aim of gradual fiscal consolidation with an amendment of the FRBM Act to set a ceiling for central government debt at 40% of GDP and general government debt at 60% of GDP, to be reached by March 2025. This is a positive step towards a more prudent fiscal framework, if eventually adhered to.
The authorities are in the process of cleaning up the banking sector, including through the allocation of USD32 billion (1.2% of GDP) in capital injections for public-sector banks. These banks are likely to need additional government capital, however, in particular after a recent high-profile fraud case involving USD2.2 billion in Punjab National Bank. Most of the capital injection is likely to be absorbed by losses associated with NPL resolution, rather than to fund new lending. Fitch expects the sector-wide NPL ratio to rise to 11.5% of total loans by end-FY18, up from 4.6% in FY15, due mainly to stricter implementation of standards.
The Indian economy is less developed on a number of metrics than many of its peers. Governance continues to be weak, as illustrated by a low score for the World Bank governance indicator (46th percentile versus the 'BBB' median of 59th percentile). India's ranking on the United Nations Human Development Index (31st percentile versus the 'BBB' median of 68th percentile) also indicates relatively low basic human development.
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 assessment that upside and downside risks to the ratings are broadly balanced.
The main factors that, individually or collectively, could trigger positive rating action are:
- A reduction in general government debt over the medium term to a level closer to that of rated peers.
- Higher sustained investment and growth rates without the creation of macro imbalances, such as from successful structural reform implementation.
The main factors that could trigger negative rating action are:
- A rise in the public-debt burden, which may be caused by stalling fiscal consolidation or greater-than-Fitch-expected deterioration in the balance sheets of public-sector banks that could prompt large-scale sovereign financial support.
- Loose macroeconomic policy settings that cause a return of persistently high inflation and widening current-account deficits, which would increase the risk of external funding stress.
KEY ASSUMPTIONS
- The world economy performs broadly in line with Fitch's latest Global Economic Outlook, published in March 2018.
- Economic activity will not be seriously disrupted by materialising political risk or social unrest.
The full list of rating actions is as follows:
Long-Term Foreign-Currency IDR affirmed at 'BBB-'; Outlook Stable
Long-Term Local-Currency IDR affirmed at 'BBB-'; Outlook Stable
Short-Term Foreign-Currency IDR affirmed at 'F3'
Short-Term Local-Currency IDR affirmed at 'F3'
Country Ceiling affirmed at 'BBB-'
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