Improvements in policymaking continue to strengthen the prospects for India's economic and fiscal performance.
GN Bureau | November 2, 2016
Standard and Poor’s global ratings affirmed its 'BBB-' long-term and 'A-3' short-term sovereign credit ratings on India. It said that the outlook is stable.
The ratings on India reflect the country's sound external profile and improved monetary credibility. India's strong democratic institutions and a free press, which promote policy stability and predictability, also underpin the ratings. These strengths are balanced against vulnerabilities stemming from the country's low per capita income and weak public finances.
S&P said that India's governing parties have made progress in building consensus on a passage of laws to address long-standing impediments to the country's growth. These include comprehensive tax reforms through the likely introduction in the first half of 2017 of a goods and services tax to replace complex and distortive indirect taxes. Other measures include strengthening the business climate (such as through simplifying regulations and improving contract enforcement and trade), boosting labour market flexibility, and reforming the energy sector.
"We believe these measures, supported by India's well-entrenched democracy, will promote greater economic flexibility and help redress public finances over time," said a press release issued on Wednesday.
India's external position remains a credit strength. The country has a floating exchange rate and limited reliance on external savings to fund its growth. While India experiences modest volatility in its terms of trade, we expect it to record a moderate current account deficit of 1.4% in 2016 (2.1% in 2015), and to average similar levels through 2018. Our forecasts are partly informed by our view of enhanced monetary policy credibility. In addition, we expect India to fund this deficit mostly with inflows without adding to debt.
It forecast that India's external debt net of public and financial sector external assets will average only 5% of current account receipts over 2016-2018 (our forecasts reflect the adoption of the sixth edition of the IMF's Balance of Payments and International Investment Position Manual).
"Although we expect some decline in India's external liquidity metrics in the next three years as its banks increasingly turn to external financing, we project that India's gross external financing needs will remain below its current account receipts plus usable reserves through 2018."
The Reserve Bank of India's foreign reserves reached $369 billion as of September 2016 (or four-and-a-half months of current account payments, $352 billion, in September 2015). The authorities also maintain contingent financing facilities of US$68 billion through bilateral swaps and contingency reserve arrangements.
A rating constraint is India's low GDP per capita, which we estimate at $1,700 in 2016. That said, India's growth outperforms its peers and is picking up modestly. We expect GDP growth of 7.9% in 2016 (6.6% in per capita GDP) and 8% on average over 2016-2018 (6.7% in per capita GDP). We believe domestic supply-side factors will increasingly bind economic performance, and the government has little ability to undertake countercyclical fiscal policy given its current debt burden.
This debt load and India's overall weak public finances are additional rating constraints. India has a long history of high general government fiscal deficits (averaging 8.8% of GDP over the past 20 years and 7% in the past five years). The deficits have not closed India's sizable shortfalls in basic services and infrastructure. The country's fiscal challenges reflect both revenue underperformance and constraints on expenditure. India's general government revenue, at an estimated 21% of 2016 GDP, is low among rated sovereigns. Its expenditure constraints are mainly related to subsidies (about 2% of 2016 GDP) for food, energy, and fertilizers. Although we expect the administration to pursue medium-term fiscal consolidation, we foresee that planned revenues may not fully materialise and subsidy cuts may be delayed.
India's high fiscal deficits have led to the accumulation of sizable general government borrowings (about 69% of GDP, net of liquid assets) and debt servicing costs (over a quarter of general government revenue). We project net general government debt to decline only modestly over our forecast horizon. A high proportion of India's resident banking sector's balance sheet is exposed to the government sector via loans, government securities, or other claims on the government (partly for regulatory requirements, as banks are required to invest 22% of their net demand and time deposits in government securities).
This implies that there may be limited capacity for India's banks to lend more to the government without further crowding out private-sector borrowing.
India's government borrowings are mostly denominated in rupees, which mitigates the risks. The small portion of external government debt is mostly sourced from official lenders over long terms and at concessional rates.
S&P said that these fiscal figures do not include losses of electricity distribution companies. Although we expect their operations to improve with lower oil prices, they will remain exposed to India's terms of trade. Hence, overall, we believe public finances are set to remain key rating constraints for some time.
It went on to say that India has a divided banking sector. Its private sector banks (about one-quarter of banking system assets) have better profitability, higher internal capital generation, and capitalization with lower-stressed assets than government-owned banks. We estimate public-sector banks need capital infusion of about $45 billion (2% of GDP) by 2019, given their weaker profitability, to meet Basel III capital norms. The government has committed US$11 billion (0.5% of GDP) to support public-sector banks. The government may have to increase the allocation if the banks are not able to secure capital from alternative sources, such as equity markets, additional tier-1 bonds, and insurance companies.
Combining our view of India's government-related entities and its financial system, we view the country's contingent fiscal risks as limited.
The Reserve Bank of India (RBI) has made progress in lowering CPI inflation following the introduction in February 2015 of its medium-term inflation target band (with 4% CPI inflation ± 2% as the principal nominal anchor for monetary policy). We expect the RBI to achieve the inflation target of 5% by March 2017 as it advances along a glide path to the medium-term inflation target. Further steps to strengthen policy formulation are being taken through the introduction of a monetary policy committee, improved communication, and efforts to strengthen monetary policy transmission (such as through new guidelines requiring banks to determine their lending rates using marginal cost of funds).
“We believe these RBI measures will support its ability to sustain economic growth while attenuating economic or financial shocks. We see some risks that strong inflows to the financial sector combined with higher inflation in India vis-à-vis its trading partners could pressure the real and nominal effective exchange rates, which in turn could hurt competitiveness, if not matched by strong productivity growth.”
The stable outlook balances India's sound external position and inclusive policymaking tradition against the vulnerabilities stemming from its low per capita income and weak public finances. The outlook indicates that we do not expect to change our rating on India this year or next, based on our current set of forecasts.
Upward pressure on the ratings could build if the government's reforms markedly improve its general government fiscal outturns and, with them, the level of net general government debt so that it falls below 60% of GDP.
Downward pressure on the ratings could re-emerge if growth disappoints (perhaps as a result of stalling reforms); if, contrary to our expectations, the new monetary council is not effective in achieving its targets; or if the external liquidity position of the nation deteriorates more than we currently expect.
|Republic of India--Selected Indicators|
|ECONOMIC INDICATORS (%)||2010||2011||2012||2013||2014||2015||2016||2017||2018||2019|
|Nominal GDP (bil. LC)||75,585||87,360||99,513||112,728||124,882||135,761||150,824||167,738||187,116||208,186|
|Nominal GDP (bil. $)||1,659||1,823||1,829||1,863||2,042||2,074||2,259||2,533||2,849||3,193|
|GDP per capita (000s $)||1.3||1.5||1.4||1.5||1.6||1.6||1.7||1.9||2.1||2.3|
|Real GDP growth||10.3||6.6||5.6||6.6||7.2||7.6||7.9||8.1||8.1||7.9|
|Real GDP per capita growth||8.8||5.2||4.3||5.3||5.9||6.3||6.6||6.8||6.8||6.7|
|Real investment growth||11.0||12.3||4.9||3.4||4.9||3.9||7.2||10.7||11.1||9.8|
|Real exports growth||19.6||15.6||6.7||7.8||1.7||(5.2)||2.8||6.6||6.7||6.9|
|EXTERNAL INDICATORS (%)|
|Current account balance/GDP||(2.9)||(6.6)||(7.8)||(3.5)||(2.7)||(2.1)||(1.4)||(2)||(2.2)||(2.2)|
|Current account balance/CARs||(10.7)||(15.1)||(18.3)||(5.9)||(4.9)||(5)||(3.5)||(5.2)||(5.8)||(5.8)|
|Net portfolio equity inflow/GDP||1.1||0.8||2.1||1.4||1.3||(0.5)||0.2||0.2||0.2||0.2|
|Gross external financing needs/CARs plus usable reserves||83.8||95.2||100.6||96.9||97.4||94.1||92.4||94.0||95.1||94.1|
|Narrow net external debt/CARs||(6.1)||4.3||10.0||9.0||8.2||8.9||8.0||5.2||2.5||(0.6)|
|Net external liabilities/CARs||45.7||33.1||41.0||30.7||32.5||40.8||40.6||36.7||32.7||28.4|
|Short-term external debt by remaining maturity/CARs||25.8||17.0||20.6||17.3||19.4||26.2||26.1||27.3||28.3||29.4|
|FISCAL INDICATORS (%, General government)|
|Change in debt/GDP||7.1||8.9||7.4||8.1||7.1||7.0||6.7||5.3||5.3||4.6|
|MONETARY INDICATORS (%)|
|GDP deflator growth||9.1||8.4||7.9||6.2||3.3||1.1||3.0||2.9||3.2||3.1|
|Exchange rate, year-end (LC/$)||44.7||51.2||54.4||60.1||62.6||66.3||66.5||66.2||66.0||65.5|
|Banks' claims on resident non-gov't sector growth||21.1||17.1||14.2||13.9||8.8||10.9||11.0||12.0||13.0||13.0|
|Banks' claims on resident non-gov't sector/GDP||53.5||54.2||54.3||54.6||53.6||54.7||54.6||55.0||55.7||56.6|
|Foreign currency share of residents' bank deposits||1.3||1.3||1.2||3.2||3.1||3.2||1.3||1.3||1.3||1.3|
|Real effective exchange rate growth||8.5||(2.1)||(4.3)||(2.2)||5.5||2.9||N/A||N/A||N/A||N/A|
|Savings is defined as investment plus the current account surplus (deficit). Investment is defined as expenditure on capital goods, including plant, equipment, and housing, plus the change in inventories. Banks are other depository corporations other than the central bank, whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial-sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. LC--Local currency. CARs--Current account receipts. FDI--Foreign direct investment. CAPs--Current account payments. The data and ratios above result from S&P Global Ratings' own calculations, drawing on national as well as international sources, reflecting S&P Global Ratings' independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.|
|Republic of India --Ratings Score Snapshot|
|Key rating factors|
|Fiscal assessment: flexibility and performance||Weakness|
|Fiscal assessment: debt burden||Weakness|
|S&P Global Ratings' analysis of sovereign creditworthiness rests on its assessment and scoring of five key rating factors: (i) institutional assessment; (ii) economic assessment; (iii) external assessment; (iv) the average of fiscal flexibility and performance, and debt burden; and (v) monetary assessment. Each of the factors is assessed on a continuum spanning from 1 (strongest) to 6 (weakest). Section V.B of S&P Global Ratings' "Sovereign Rating Methodology," published on Dec. 23, 2014 , summarizes how the various factors are combined to derive the sovereign foreign currency rating, while section V.C details how the scores are derived. The ratings score snapshot summarizes whether we consider that the individual rating factors listed in our methodology constitute a strength or a weakness to the sovereign credit profile, or whether we consider them to be neutral. The concepts of "strength", "neutral", or "weakness" are absolute, rather than in relation to sovereigns in a given rating category. Therefore, highly rated sovereigns will typically display more strengths, and lower rated sovereigns more weaknesses. In accordance with S&P Global Ratings' sovereign ratings methodology, a change in assessment of the aforementioned factors does not in all cases lead to a change in the rating, nor is a change in the rating necessarily predicated on changes in one or more of the assessments.|
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