MARC has assigned a long-term foreign currency country ceiling of AA with a stable outlook for foreign currency debt to India on its national rating scale. The Government of India (GOI) has no debt rated by MARC; the country ceiling applies to ringgit-denominated issuances by entities domiciled in India following the rating agency’s decision to incorporate transfer and convertibility (T&C) risk into its assessment of ringgit-denominated debt issuances by foreign issuers. MARC’s sovereign rating methodology was employed to establish the foreign currency country ceiling for India on the rating agency’s national rating scale. The rating is based solely on an analysis of information in the public domain.

The rating is supported by the country’s manageable external debt position and the GOI’s commitment to maintain economic and financial system stability. The maturity structure of the country’s external debt and its level relative to India’s foreign exchange reserves, as well as the sustainability of relatively low external debt and associated debt service to GDP ratios should continue to support the foreign currency country ceiling despite near-term uncertainties and risks arising from the GOI’s strained fiscal position, balance of payments vulnerabilities and deteriorating global economic conditions. The need for concrete moves on the economic reform front is highlighted by India’s widening trade deficit, surge in capital outflows and growing budgetary pressures. In this regard, MARC notes that India’s reform record over the past year is mixed, due in part to challenges related to building a political consensus on economic reforms, but an increased awareness of costs associated with deferring reform appears to have fostered a renewed commitment to advance reforms in 2012.

The rating also acknowledges India’s relative resilience to global economic headwinds. India fared well with annual GDP growth of above 6.0% during the global recession, its primary drivers of growth being domestic in nature. MARC believes that India remains well placed for a period of reasonable economic growth due to its relatively high domestic savings and investment rates, the favourable demographics of its working age population, its growing middle class population which is expected to support strong consumption demand, as well as sustained investment in infrastructure. At the same time, wide variations in inter-state growth rates, growth of per capita income and social development are noted. India’s fairly high domestic savings rate of 34% of GDP supports a similarly high level of investment. In addition, investment ratios are expected to benefit from the ongoing liberalisation in foreign investment restrictions. Meanwhile, the GOI’s policy initiatives to strengthen India’s export sector should assist in narrowing the country’s trade deficit and diversifying its economic structure in the intermediate to longer term horizon.

The rating is constrained by India’s large and growing public sector debt, its public finances which are characterised by a combination of expenditure rigidity and revenue volatility, structural deficits in its external accounts, as well as market rigidities and infrastructure deficiencies that weaken competitiveness and hinder the growth of its agriculture and manufacturing sectors.

The increasing fiscal deficits of the central and state governments over the last several years largely reflect the use of fiscal expansion to counter the effects of the global financial crisis. While comprehensive market-based reforms following a balance of payments crisis in 1991 had put the country on a path of rapid economic growth and its fiscal position on the mend, the GOI’s prior progress with fiscal tightening was reversed in 2008-09 and 2009-10 with the global financial crisis. MARC notes that the consolidated general government deficit, which provides a combined picture of deficits of the central and state governments, had declined to 7.7% of GDP in 2010-11 from 9.3% in 2009-10. Efforts to increase tax revenue, restrain spending and privatise public enterprises will be important steps towards narrowing the fiscal deficit which has been largely financed through domestic borrowings.

The GOI had budgeted a central government fiscal deficit of 4.6% of GDP for the fiscal year ending March 31, 2012, but slippage in fiscal performance appears certain on account of higher-than-anticipated subsidy requirements and lower receipts from the divestment of equity of public sector enterprises. Capital expenditure on account of equity infusion in public sector banks to meet upcoming Basel III norms will pose additional challenges to the GOI’s fiscal consolidation efforts in subsequent periods. The setback suffered by India’s ruling Congress Party in recent elections involving five states across the country may also prove to be somewhat disruptive to fiscal consolidation efforts and structural reforms.

India’s high fiscal deficit has also contributed to its high and persistent inflation, of which food (and food supply shocks) and fuel inflation are primary drivers. The sharp depreciation of the Indian rupee against the US$ in the last six months of 2011 had earlier posed an added challenge for reining in domestic inflation, having negated the impact of softening global commodity prices. Although the sharp decline in food inflation together with the moderation in fuel inflation has helped ease headline inflation since November 2011, the recent February 2012 inflation data indicates an upturn in inflation. Lingering inflationary concerns are expected to limit near-term monetary policy options, particularly the lowering of interest rates to support growth.

The ratio of India’s short-term external debt to total external debt stood at a manageable level of 21.9% as at end-September 2011. India’s external debt-to-GDP ratio of 17.4% for 2010-11 and ratio of foreign exchange reserves to debt of 99.6% as of end-June 2011 indicate comfortable debt service capacity. These external debt sustainability indicators could have weakened somewhat from the aforementioned levels on account of the depreciation of the rupee and the decline in foreign exchange reserves but are expected to remain consistent with the assigned rating. To halt the earlier slide in the rupee and significant foreign capital outflows from the domestic equity market, RBI signaled the end of its monetary tightening cycle and had apparently intervened in the currency market. The recent rebound in rupee-denominated bond investments and equity investments by international investors in January 2012 has reversed the depreciating trend of the rupee against the US$. Continuing commitment on the part of the GOI to make the policy environment more conducive to foreign capital inflows, meanwhile, is evidenced by its recent decision to allow qualified foreign investors to directly invest in the Indian equity market.

The stable outlook balances India’s high long-term growth potential and comfortable external debt position with its fiscal and current account deficits, continued high public sector borrowing and the challenge of advancing fiscal reforms. MARC believes that public support for the country’s broad-based economic growth strategy provides assurance that the incentives to advance reforms will remain after the state elections, although the pace may be affected. The foreign currency country ceiling incorporates measured progress in containing the fiscal deficit and the receding risk of recent balance of payments pressures.

Contacts:
Milly Leong, +603-2082 2288/ milly@marc.com.my;
Sharidan Salleh, +603-2082 2254 / sharidan@marc.con.my;
Sandeep Bhattarcharya, +603-2082 2247/ sandeep@marc.com.my.