Fitch upgrades India on better external note

Over the past few years, India’s BoP has strengthened considerably owing to booming services exports primarily in it and it-related sectors and healthy remittances. Combined with buoyant foreign portfolio capital inflows and a steady influx of non-resident Indian (NRI) deposits, this has led to a sharp increase in official foreign currency reserves which have nearly doubled since December 2001 to over $ 100 billion. The country’s vulnerability to external shocks and BoP constraint on growth have both eased significantly, it said.

Fitch said “it does not expect National Elections this year to cause excessive uncertainty or major changes in the direction of reform” and notes that “India’s robust democratic institutions leave it less exposed to political transition risks than some similarly rated sovereigns.” But the pace of reform could suffer if the cohesiveness of the new coalition government is reduced.

Referring to public finances, Fitch said the general government deficit at 10 per cent of gross domestic product is three times the ‘BB’ median. The risks of a fiscal financing crisis over medium term are mitigated as most of the government debt is held domestically, denominated in rupee and bearing long maturities. And with GDP growth picking up and domestic interest rates having declined, adverse public debt dynamics will remain slow burn in the near term.

“India cannot rely on such a favourable macro picture for too long and needs to cut fiscal deficits to stabilise its debt burden,” it warned adding, “failure to take advantage of propitious macroeconomic conditions to commence fiscal consolidation this fiscal, with government recently opting to announce further tax cuts instead, is unfortunate.”

Passage of the fiscal responsibility and budgetary management law last year represents a welcome commitment but it remains to be seen whether this would be backed up by genuine political resolve, it said.

With interest payments accounting for over 30 per cent of government revenue, far higher than any investment grade rated sovereign, continued fiscal deterioration could weigh more heavily on India’s ratings over time. Fitch believes that broader pace of structural reform remains disappointingly slow including in areas of labour market reform, privatisation and most importantly, tax reform. The pace of reform would need to accelerate sharply in order to push India on to a path of sustainable medium term growth in excess of six per cent, it added.