Economy India
Artha DeshBanking and Finance

Fitch Affirms India at ‘BBB-‘; Outlook Stable, GDP growth of 6.9% in the fiscal year ending March 2024

New Delhi

Global Rating Agency Fitch Ratings has affirmed India’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘BBB-‘ with a Stable Outlook.

GDP growth of 6.9% in the fiscal year ending March 2024

KEY RATING DRIVERS

Robust Growth, Fiscal Challenges: India’s rating is underpinned by a robust medium-term GDP growth outlook and sound external finances, which remain intact as the country has effectively navigated a fraught external environment in the past few years. Weak public finances – illustrated by high deficits, debt and interest/revenue ratio compared with peers – continue to be the largest constraint for the rating. Lagging structural metrics, including World Bank governance indicators and GDP per capita, also weigh on the rating.

Growth Outperforming Peers: India is poised to remain one of the fastest-growing countries globally in the next few years as the robust economic momentum is proving resilient. We forecast GDP growth of 6.9% in the fiscal year ending March 2024 (FY24), well above our 6.0% FY24 forecast from our last review in May 2023, before easing to 6.5% in FY25. Investment is likely to remain a key growth driver, as the government’s capex drive is likely to continue and private investment should accelerate gradually. Consumption is likely to moderate further in the near term due to reduced household savings buffers.

Strong Growth Prospects: We estimate India’s potential GDP growth at 6.2%, underpinned by the government’s infrastructure drive, a solid private investment outlook and favourable demographics. The improved health of bank and corporate balance sheets should pave the way for a positive investment cycle. Sustained reforms could support and boost growth prospects, but risks may arise from an uneven implementation record. Labour market weakness, partly reflected in low female participation, also poses a risk to the outlook.

Core Inflation Contained: Headline inflation was volatile in 2023 due to food price shocks, periodically exceeding the Reserve Bank of India’s (RBI) 2%-6% target band. However, core inflation decelerated, reaching 3.7% in December from around 6% at end-2022, which should help anchor headline inflation. We forecast headline inflation to ease towards 4.7% by end-2024 from 5.7% in December 2023. Under this inflation outlook, we see the RBI cutting its policy rate by 75bp in FY25.

Improving Banking Sector: Sustained improvements in asset quality and profitability have strengthened bank balance sheets, which supports the economic outlook. Non-performing loans fell to about 3% of total loans in September 2023 from a peak of nearly 11% in 2017. We expect private-sector credit growth to remain high, at around 15%, in FY24 (adjusting for a large bank merger), driven by the service sector and retail loans, particularly housing and consumer credit segments. The RBI recently tightened macroprudential settings for unsecured consumer credit, which should cut financial stability risks.

Deficit Target to Be Met: We forecast the general government (GG) fiscal deficit will remain elevated, at 8.6% of GDP in FY24 (2023 BBB median: 3.5%) from 9.2% in FY23. We expect the central government (CG) to achieve its 5.9% of GDP FY24 deficit target from 6.4% in FY23. Revenue collection is buoyant as the 2016 goods and services tax reform matures. Expenditure quality has improved as capex is largely in line with the budget’s ambitious plans. Subsidy and income support spending has risen beyond budget expectations, but we expect spending to be managed to meet the target, even in an election year.

Difficult Consolidation Path: Beyond FY24 there is less certainty on the fiscal path and trade-offs between economic growth and consolidation may become more acute. We forecast the GG deficit to narrow further to 8.1% of GDP in FY25, based on a CG deficit of 5.4%. The CG will present an interim FY25 budget on 1 February 2024 before the national election, but additional policy announcements will be in the post-election budget in mid-2024. We expect the aggregate state deficit to remain around 2.8% of GDP.

The CG’s medium-term fiscal guidance is for a 4.5% of GDP deficit by FY26, but details on how this will be achieved are still limited. The CG has demonstrated a recent commitment to meeting fiscal targets, but reaching this target will require more than the 0.3pp and 0.5pp in deficit reduction in FY23 and FY24, respectively. Sustaining high levels of capex is likely to remain a key objective to foster GDP growth, but in the absence of further sizeable revenue-raising measures, spending cuts are likely to be the key driver for narrowing the deficit.

Stable, High Public Debt: We forecast GG debt will remain high, at 82.7% of GDP at FYE24 (56% for BBB peers). This is higher than the 81% at FYE23, as nominal GDP growth slowed. Our debt dynamics show the debt ratio declining slightly to just above 80% by FY28, even with strong 10.5% nominal GDP growth, as consolidation is set to be gradual. A high interest payment/revenue ratio of around 25% in FY24 (BBB median: 8.5%) is a structural weakness. We believe limited rebuilding of fiscal buffers amid high GDP growth narrows fiscal headroom from a ratings perspective to respond to potential economic shocks.

Continuity Likely After Elections: India’s general election is likely to be held in April-May 2024. Polls indicate that the incumbent government led by the Bharatiya Janata Party under Prime Minister Narendra Modi will be re-elected, even as much of the opposition has coalesced under a broad coalition. As a result, we expect policy continuity, with gradual fiscal consolidation and economic reform momentum.

Surging Portfolio Inflows: We expect foreign-exchange (FX) reserves to continue rising due to large portfolio inflows, particularly into equity markets, and a narrower current account deficit, which we forecast at 1.4% of GDP in FY24 and FY25. FX reserves hit USD623 billion (7.8 months external payments) by end-2023, up by nearly USD40 billion since October.

The RBI managed the exchange rate in a narrow range of 81-83 per US dollar in 2023, intervening to maintain stability and more recently to build reserves. Further inflows should push FX reserves to USD654 billion by end-2024, with Fitch expecting nearly USD25 billion from India’s inclusion in the JP Morgan Global Bond Index by March 2025, among other flows.

ESG – Governance: India has an ESG Relevance Score of ‘5’ for Political Stability and Rights and ‘5[+]’ for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators have in our proprietary Sovereign Rating Model. India has a medium World Bank Governance Indicator ranking at 47.9, reflecting a record of peaceful political transitions, rights for participation in the political process, moderate institutional capacity, established rule of law and moderating levels of corruption.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

– Public Finances: Rising general government debt/GDP ratio, for instance, from insufficient fiscal consolidation or an economic shock.

– Macro: A structurally weaker real GDP growth outlook that further weighs on the debt trajectory or prevents a closer alignment of per capita GDP with the peer median.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

– Public Finances: Implementation of a credible medium-term fiscal strategy, for instance, from further revenue-enhancing reforms, which lowers the general government debt and interest/revenue ratio towards the levels of ‘BBB’ category peers.

– Macro: Higher medium-term investment and growth rates without the creation of macroeconomic imbalances, such as from successful structural reform implementation.

SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)

Fitch’s proprietary SRM assigns India a score equivalent to a rating of ‘BB+’ on the Long-Term Foreign-Currency (LT FC) IDR scale.

Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:

– Macro: +1 notch, to offset the deterioration in the SRM output from GDP volatility, which reflects a substantial and unprecedented exogenous shock that hit the majority of sovereigns. We believe that India absorbed the pandemic shock without lasting effects on its long-term macroeconomic stability and that the shock added excess volatility to the rating.

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 LT FC 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.

COUNTRY CEILING

The Country Ceiling for India is ‘BBB-‘, in line with the LT FC IDR. This reflects no material constraints and incentives, relative to the IDR, against capital or exchange controls being imposed that would prevent or significantly impede the private sector from converting local currency into foreign currency and transferring the proceeds to non-resident creditors to service debt payments.

Fitch’s Country Ceiling Model produced a starting point uplift of +0 notches above the IDR. Fitch’s rating committee did not apply a qualitative adjustment to the model result.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

India has an ESG Relevance Score of ‘5’ for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As India has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.

India has an ESG Relevance Score of ‘5[+]’ for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As India has a percentile rank above 50 for the respective Governance Indicators, this has a positive impact on the credit profile.

India has an ESG Relevance Score of ‘4’ for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As India has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.

India has an ESG Relevance Score of ‘4[+]’ for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for India, as for all sovereigns. As India has a record of more than 20 years without a restructuring of public debt that is captured in our SRM variable, this has a positive impact on the credit profile.

The highest level of ESG credit relevance is a score of ‘3’, unless otherwise disclosed in this section. A score of ‘3’ means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch’s ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch’s ESG Relevance Scores, visit

 

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