S&P upholds India’s credit rating at BBB- with stable outlook

The rating action will provide huge relief to the government as last week Moody’s Investors Service downgraded India’s sovereign rating one notch to the lowest investment grade with negative outlook. Fitch Ratings on Wednesday said lack of a credible medium term strategy for stabilizing rising public debt in India after the coronavirus crisis subsides could put downward pressure on its sovereign rating.

“While risks to India’s long-term growth rate are rising, ongoing economic reforms, if executed well, should keep the country’s growth rate ahead of peers.

The economic hit from COVID-19 will exacerbate India’s weak fiscal settings. We expect a materially larger fiscal deficit this year, followed by consolidation over the next three years,” S&P said.

However, S&P cautioned that downward pressure on India’s sovereign rating could emerge over the next one to two years if India’s GDP growth fails to meaningfully recover from 2021 onwards, and its trend growth rate falls towards the average of its peers; and net general government deficits materially exceed S&P’s forecasts, signifying a weakening of India’s institutional capacity to maintain sustainable public finances. On the upside, S&P could upgrade India’s rating if the government significantly curtails its fiscal deficits, resulting in materially lower net indebtedness at the general government level.

The rating agency expects a spike in the general (centre and states) government’s fiscal deficit to 11% of GDP in FY21. “We consider the proposed float of shares of government-owned Life Insurance Corp. of India (LIC) to be crucial for the government to consolidate its fiscal position following the spike in the deficit this year. On balance, we expect the deficit to decline meaningfully next year, well below 10% of GDP, assuming that the economy has stabilized and entered into recovery,” it added.

S&P said its stable outlook for India reflects expectation that India’s economy will recover following the containment of the covid-19 pandemic, and the country will maintain its sound net external position. S&P has projected Indian economy to contract by 5% in FY21 before making a strong recovery to grow at 8.5% in FY22. “The economy’s long-term outperformace (of its peers) highlights its resilience. India’s wide range of structural trends including healthy demographics and competitive unit labor costs work in its favor. A more favorable corporate tax regime, which is particularly supportive of manufacturing firms, should reinforce growth, alongside additional fiscal and monetary easing,” it added.

The rating agency said prime minister Narendra Modi’s robust mandate may empower the government to adopt and enact important economic reforms, such as further liberalization of India’s labor markets and investment framework.

Last month, government announced a ₹21 trillion financial package to ease liquidity conditions for small industries and support vulnerable sections of the society. S&P said direct government expenditure under the program is limited at less than 2% of GDP.

“We believe that this reflects the limited fiscal space that the government retained coming into the crisis. To further support the economy and India’s financial markets, the government will lean heavily on guarantees (both from the centre as well as state governments), as well as the banking sector and RBI. However, we believe that the immediate fiscal impulse to growth is limited, as the measures are generally calibrated towards averting further structural damage to the economy,” it added.