India Joins the Investment-Grade Club
Standard & Poor's Ratings Services raised its sovereign credit ratings on the Republic of India on Jan. 30 to BBB- from BB+. The outlook is stable. The upgrade to investment grade reflects the country's strong economic prospects and external balance sheet, and its deep capital market, which supports a weak but improving fiscal position.
"India's economic prospects remain strong and are rising gradually, with GDP trend growth likely to average more than 7.5% in the medium term," says Standard & Poor's credit analyst Ping Chew. "Gradual reforms and consistent monetary and fiscal policy stances have also sustained macroeconomic stability. This has led to strong growth prospects and attracted foreign and nonresident Indian capital. India's strong institutions have also provided for relative stability in policy, politics, and business environments against volatility usually associated with lower income levels."
Strong Capital Inflows
Moreover, India's external balance sheet is strong due to reserves accumulation and prudent debt management. Its foreign-exchange reserves, now more than 16 times short-term debt and five times gross financing requirements, provide a buffer from changes in external and domestic investor confidence. These strengths are likely to continue, despite the current account deficits, on the expectation of strong capital inflows.
The upgrade also reflects an improving fiscal position. Fiscal consolidation commitments across all levels of governments look to be entrenched, according to Chew. "Governments are likely to be able to manage the fiscal vulnerabilities," he says. "India also has a well-functioning bond market, especially when compared with its rated peers and income group, providing long-term financing for the government's deficits."
Standard & Poor's thinks the pace of deficit narrowing should continue, and at a faster pace than the rating agency's initial projection. The central government's budget deficit for the current year seems to be back on track to meet its target of 3.8% of GDP due to strong revenue collection.
High Debt Burden
State governments' fiscal estimates for the current year suggest that the combined central and state government deficit is likely to fall below 7% of GDP. The secular decline in general government deficits in the medium term is likely to continue due to tax reform and improved administrations, and implementation of fiscal responsibility laws across more state governments, currently enacted by 23 out of 29 state governments.
However, India's ratings remain constrained by the country's weak fiscal profile, especially its high government debt burden and deficit, which is still one of the worst among all rated sovereigns. Further rating improvements will depend on sustained prudent fiscal policy that leads to a decline in the government debt and interest burden, and further reforms that lift the country's growth prospects and income levels.
Chew also cautions that an inappropriate policy mix that increases the vulnerability of India's still-weak fiscal flexibility could lead to downward pressures on the rating.