Fitch Ratings On India’s Tightrope Walk Between Stimulus And Government Debt

India needs to walk a tightrope on balancing the macroeconomic need to spend with implications for government debt, says Fitch.

A young man balances on a tightrope. (Photographer: Dado Galdieri/Bloomberg)
A young man balances on a tightrope. (Photographer: Dado Galdieri/Bloomberg)

Increased government spending may be the right macro economic approach at a time when the Indian economy is facing its first recession in nearly four decades, but it will weaken the country’s credit metrics further. That’s according to Stephen Schwartz, head of Asia-Pacific sovereign ratings at Fitch Ratings.

The rating agency, on June 18, changed the outlook on India’s rating to ‘negative’ from ‘stable’, citing the increase in the country’s debt-to-GDP ratio to an estimated 84.5% in FY21. The medium-term fiscal outlook, the rating agency said, is very uncertain and will depend on the level of GDP growth and the government’s policy interventions.

Fitch said it expects the Indian economy to contract by 5% this financial year.

Should the Indian government then try and spend its way out of this crisis? This, in turn, would also help bring the country’s debt-to-GDP ratio back to a sustainable path by ensuring a higher denominator.

Schwartz said that India would need to walk a tightrope on balancing the macroeconomic need to spend with the implications for government debt and sovereign ratings.

For a country like India, that already had a high public debt ratio going into the crisis, even if it’s the right macro response to spend more as the crisis unfolds, it does undermine credit metrics, credit worthiness and from a ratings perspective leaves India weaker than it was going into the crisis.
Stephen Schwartz, Head - Asia-Pacific Sovereign Ratings, Fitch Ratings

He said that while fiscal measures may help spur growth, it would create uncertainty about the medium-term debt trajectory. “So, it's a double edged sword as you think about the fiscal stimulus for countries that had little fiscal space going into a crisis.”

A part of the problem, Schwartz explains, was India’s relatively high debt-to-GDP ratio of 71% in FY20 going in to the crisis. This was significantly higher than the median of 42.2% of GDP for the ‘BBB’ category in 2019.

This may make it difficult for the Indian government to undertake steps needed to support the economy.

“From a macroeconomic perspective, stimulus measures are the right thing to do. There is a pressing health crisis. Businesses are closed under lockdown restrictions, workers are being laid off. So, both from a social and macroeconomic perspective, fiscal measures are the right policy response as is expansionary monetary policy,” Schwartz said. “However, from a ratings perspective where we are assessing credit worthiness and the relative fiscal metrics and credit strengths against other similar countries.”

Over the past few weeks, all three large global rating agencies have reviewed India’s sovereign rating. Moody’s Investors Service, which had a rating one notch higher than others, downgraded India by one notch and retained a negative outlook on the rating. Standard & Poor’s reaffirmed India’s rating and the outlook. Fitch has retained the sovereign rating but changed the outlook to negative. Across all three agencies, India has an investment grade rating.

A downgrade by Fitch Ratings or a further downgrade by Moody’s could push India into junk territory.

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Countries across the region are also grappling with the financing of increased government spending. While developed market central banks have embarked on large asset purchase programmes, emerging economies don’t have that luxury.

Schwartz said central banks across Asian emerging economies have focused on ensuring smooth functioning of financial markets while developed market central banks have targeted the cost of borrowing. Still, they’ve gone further than in the past to support bond markets.

“Indonesia has gone all the way to make purchases in its primary market—that’s something that we haven’t seen in emerging markets and other countries such as the Philippines have been active in the secondary market in trying to stabilise bond yields and prevent a big sell off in the bond market,” he said. “This is increasing the balance sheets of these central banks and it will create a challenge for them to unwind it in a non-inflationary way after the crisis passes, in a way that doesn’t destabilise markets.”

Will such monetisation of government deficits impact a country’s rating?

Schwartz said the impact may depend on the exit strategy from unconventional policy steps taken by central banks.

As long as this is a time-bound programme, its size is capped and it’s put in the context of a medium-term strategy and exit; we can kind of see through that and we wouldn’t see it as having an immediate ratings impact but those are a lot of ifs and uncertainties. Many of these central banks are really embarking on unprecedented measures which are called for a time like this. But again, we’ll have to assess the impact when we come out of it.
Stephen Schwartz, Head - Asia-Pacific Sovereign Ratings, Fitch Ratings

In India, the central bank has been relatively conservative even though it has stepped in from time to time in the secondary government bond market. It has also cut rates sharply and ensured surplus liquidity.

Schwartz believes there is still monetary space across most Asian economies and in India, thanks to continuing moderate inflation.

Monetary space, many countries still have some room for additional interest rate cuts as inflation, just about everywhere, is really low or even negative in some countries. So, that gives a bit of space to lower interest rates in this environment, especially for central banks that have built up good track records and credibility under their inflation targeting framework, they can probably get away with some more rate cuts.
Stephen Schwartz, Head - Asia-Pacific Sovereign Ratings, Fitch Ratings

Watch the full interview below:

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