Fitch Ratings-London-1 August 2006: Fitch Ratings today upgraded the Republic of India's Long-term foreign and local currency Issuer Default Ratings ("IDRs") to 'BBB-' (BBB minus) from 'BB+', both with Stable Outlooks. The Short-term foreign currency IDR is also raised to 'F3' from 'B' and the Country Ceiling is upgraded to 'BBB-' (BBB minus) from 'BB+'.
"This upgrade reflects Fitch's view that fiscal consolidation is at last taking hold in India, reinforced by the impressive growth story and India's strong external balance sheet. Public finances are still weak, but they are no longer an insuperable constraint on this rating," says Paul Rawkins, Senior Director in Fitch's Sovereign team in London.
Fitch says that for the first time since it started rating India in March 2000, there appears to be near universal commitment among the centre and the states to fiscal consolidation. This sea change in policy intent, coupled with a more discernable path of fiscal consolidation than previously appeared to be the case, has reduced the risk that India's weak public finances could impair its strong external financial position. Although still high, revised data show the general government deficit declining to 7.5% in 2005/06 from 10.1% of GDP in fiscal year 2001/02. Higher growth and lower interest rates have played a part in this outcome but so, too, have much improved tax administration and some widening of the tax net. Modest tightening at the centre has been matched by parallel progress among India's 25 states and union territories, many of which have introduced value-added tax and enacted fiscal responsibility legislation over the past year.
Fitch acknowledges that, at 84% of GDP, the public debt ratio remains far above the 'BBB' median (34%) and has been slow to respond to higher growth. However, the agency argues that India has long demonstrated an ability to sustain much higher debt levels than many of its rating peers. An established track record of macroeconomic stability, low inflation and a high domestic savings rate have been key, coupled with a deep domestic capital market and external capital controls, says Fitch.
An important by-product of the government's heavy reliance on the domestic debt market to fund its borrowing requirement has been the build up of a net public external creditor position in contrast to many other 'BBB' rated sovereigns. The agency says this, plus an unblemished debt service record, in contrast to many of its rating peers, represent important sovereign rating attributes weighing strongly in the balance against India's weak public finance ratios.
Fitch says India's structural reforms, gradual though they may appear, are starting to reap dividends: the economy has been growing at close to 8.5% per annum since 2003/04, notwithstanding the oil price shock, an earlier precursor of which brought the economy to its knees in the early 1990s. While noting that higher oil prices have taken their toll of inflation and the balance of payments, the agency says that neither are the constraints that they once were on growth. India is expected to encounter little difficulty in financing a larger current account deficit of 2.4% of GDP in 2006/07: the gross external financing requirement is estimated at just 18% of reserves, well below the 'BBB' median of 74%, underlining the fact that USD155 billion of international reserves buys significant insurance against external shocks.
Despite its more upbeat assessment of the country's public finances, Fitch says that growing signs that private sector borrowers are being 'crowded out' indicate that the public sector borrowing requirement is still incompatible with India's growth aspirations. Credit growth is outstripping deposit growth, raising fears of a credit crunch which, together with rising inflation expectations, have formed the backdrop to higher interest rates since 2004.
"Henceforward, fiscal consolidation will remain the main focus of this rating, particularly in the context of such strong growth, as will the need for a renewed push on structural adjustment," said Fitch's Rawkins.
