Fitch Revises India’s Sovereign Rating Outlook To Negative

Fitch Ratings has revised its India outlook to negative from stable, while maintaining the rating at BBB-.

Indian one hundred rupee banknotes are arranged for photograph in India. (Photographer: Dhiraj Singh/Bloomberg)
Indian one hundred rupee banknotes are arranged for photograph in India. (Photographer: Dhiraj Singh/Bloomberg)

Fitch Ratings Ltd. revised India’s long-term outlook to negative from stable, citing risks due to continued acceleration in the number of new Covid-19 cases as the country eases lockdown curbs.

The coronavirus pandemic has significantly weakened India’s growth outlook for this year with economic activity expected to contract 5% in the current fiscal, before rebounding by 9.5% by 2021-22, the global credit rating agency said in a release, as it affirmed the country’s rating at ‘BBB-’.

“It remains to be seen whether India can return to sustained growth rates of 6-7% as we previously estimated, depending on the lasting impact of the pandemic, particularly in the financial sector,” it said.

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.

Medium-Term Growth

According to Fitch, India’s medium-term gross domestic growth outlook may be negatively affected with banks and non-bank lenders facing new asset-quality challenges.

“The financial sector was already facing weak business and consumer confidence before the crisis and authorities had to deal with some high-profile cases over lapses in governance,” it said.

Though the banking sector’s non-performing asset ratio improved to 9% in the financial year ended March 2019 through government capital injections, a new wave of bad loans necessitates further financial government support despite regulatory measures announced by the Reserve Bank of India, Fitch said.

Structurally, India’s real GDP growth is much weaker due to financial-sector risks and the lack of reform implementation, Fitch said.  

But the recent measures and reforms announced by the government in response to the pandemic, if implemented well, will help strengthen GDP growth over the medium term in addition to India’s fiscal position, the statement said.

The rating agency also expects the RBI to cut its policy rate by at least another 25 basis points this fiscal, currently at 4%, as the spike in food prices is receding and some price movements are displaying a disinflationary scenario in the current environment.

“A credible inflation-targeting framework in place since 2016 makes debt reduction through high inflation less likely over the medium term. India experienced double-digit inflation in the few years immediately following the deterioration in fiscal metrics during the global financial crisis,” Fitch said.

Fitch also cited geopolitical and political risks as part of its outlook.

A stronger focus by the ruling Bharatiya Janata Party on its Hindu-nationalist agenda since the government’s re-election in May 2019 risks becoming a distraction for economic reform implementation and could further raise social tensions.
Fitch Ratings

Fiscal And Debt Outlook

According to Fitch, fiscal metrics have deteriorated significantly due to the impact of a growth slowdown on revenue, fiscal deficit and public sector debt ratios.

Fitch expects general government debt to jump to 84.5% of GDP in FY21 from an estimated 71.0% of GDP in FY20. This is significantly higher than the median of 42.2% of GDP for the ‘BBB’ category in 2019, to which FY20 corresponds, and 52.6% for 2020.

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. “India’s record of fiscal consolidation has been mixed since the 2008 global financial crisis, with the general government debt remaining broadly stable at close to 70% of GDP for over a decade.”

Despite double-digital nominal GDP growth in recent years there has not been a decline in the government’s debt ratio, mainly due to crystallisation of contingent liabilities and significant off-budget financing, it said.

“Weak implementation of fiscal rules stipulated in the Fiscal Responsibility and Budget Management Act contributes to our view that a speedy fiscal improvement after the pandemic recedes is unlikely,” the report said.

Fitch’s estimates that the government’s relief package to fight the virus outbreak represents a fiscal outgo of 1% of GDP. That’s because most elements of the package equivalent to 10% of GDP actually are non-fiscal in nature, it said.

“Some further fiscal spending of up to 1 percentage point of GDP may still be announced in the next few months, which was indicated by a recent announcement of additional borrowing for FY21 of 2% of GDP, although we do not expect a steep rise in spending,” the rating agency said.

With the government planning to open up domestic capital markets to foreign capital, as a source of deficit financing, it largely depends on investors’ tolerance and willingness to invest in government papers against such high debt levels that include a significantly large portion of external debt, Fitch said.

The government, it said, should implement a credible strategy to reduce overall debt levels after the pandemic to improve its rating profile, besides ensuring higher investment and growth rates through structural reforms and a healthier financial sector.

Policy Implications

Divergent views are adopted by the three rating agencies, but the focus on medium-term growth by each may impact policy preferences.

“Much of the recent public debate in India has implicitly focused on what size of fiscal response may be acceptable to ratings agencies this year? Instead, as we have tried to previously emphasise, ratings agencies would eventually care about medium-term debt sustainability which, in turn, hinges much more on trend growth than any one year’s fiscal impulse,” Sajjid Chinoy, chief India economist at JPMorgan, had said in a note prior to Fitch’s review. “Fiscal capacity, and therefore ratings, will eventually come down to perceptions about medium-term growth,” he said.

According to Chinoy, the economic policy response to Covid-19 needs to be calibrated to the size of the economic shock in India so as to prevent “economic non-linearities from taking hold (viable firms being forced to close down, financial sector freezing up, labour market stress getting amplified) that will hurt trend growth”.

While Moody’s and S&P have forecast the fiscal deficit to widen to 11% of GDP in the current year, he said there is nothing sacrosanct about this forecast.

If the size of the shock necessitates more fiscal support to hold the economy together and preserve medium-term growth, then more should be forthcoming. Equally imperative, however, is that the extra fiscal support come with a clear and credible fiscal consolidation plan post-Covid, given India’s stretched starting points.
Sajjid Chinoy, Chief India Economist, JPMorgan

Crucial 2021

Nomura Global Markets Research, in a separate report, said while economic growth over the next six months is uncertain, rating agencies will be watchful of growth in 2021. That’s because it would be a crucial year for the economy to recover and allay the macroeconomic and fiscal concerns, Nomura said after Fitch’s review.

While all rating agencies concur that current conditions do not warrant a rating downgrade (to junk), they are concerned by the direction of macro fundamentals, and would like to see the resolution of some of these uncertainties before providing a final evaluation on ratings.
Sonal Varma, Chief Economist, India and Asia (Ex Japan), Aurodeep Nandi, India Economist & Vice-President, Nomura