Standard & Poor’s Ratings Services has revised the outlook on India’s ‘BB’ long-term foreign currency rating to stable from negative to reflect the sovereign’s improving external finances. The outlook on India’s ‘BB+’ long-term local currency rating remains negative because of the government’s continuing difficulty in addressing its fiscal problems and structural reforms. Both foreign and local currency short-term ratings on the sovereign were affirmed at ‘B’.
“Rapidly increasing external liquidity, sustained by growing foreign exchange reserves (exceeding 700% of short-term debt), and modest debt service payments sparked the revision in the foreign currency outlook,” says Standard & Poor’s credit analyst Takahira Ogawa, director in the Asia-Pacific Sovereign Ratings Group. Foreign exchange reserves should equal about 490% of India’s gross external financing gap (current account deficit plus amortization and short-term debt) in 2003, compared with 90% or so in similarly rated countries. This is a major supporting factor for the sovereign ratings on India.
India’s stable and good economic prospects is another factor supporting the sovereign ratings. India is expected to achieve a 5-6% trend rate of GDP growth in the medium term, which should help cushion the impact of its high fiscal deficit and restrain the rise in the government’s heavy debt burden.
“Nevertheless, rising public debt and increasing fiscal inflexibility remain the most pressing issues for the government,” Ogawa says. The consolidated direct debt of India’s state and central governments is expected to be 84% of GDP in fiscal 2003, which is high for the rating category. Moreover, this level is expected to rise steadily because of the high consolidated general government deficit, which at more than 9% is one of the highest of all sovereigns rated by Standard & Poor’s.
The government must also accelerate progress in structural reform. Resistance from vested interests, including bureaucrats and politicians, has hindered government efforts to reduce restrictions such as land ownership and labour markets. In addition, continued over-protection of small-scale industries has lowered the country’s growth prospects to current level.
Although deregulation and privatisation are slowly taking place, public sector reform has not yet started. Annual borrowing by the state and central governments and their enterprises equal almost the entire financial savings of the country. A growing share of public spending is diverted to meet interest payments and salaries for a bloated civil service. As a result, public investment declined to only 6% of GDP, from 10% a decade ago.
“The outlook on India’s local currency ratings could be revised to stable if the government manages to reverse its fiscal trajectory by reducing the deficit and accelerating structural reform. This would also improve prospects for the foreign currency rating. On the other hand, if deficits remain large and debt continues to rise, or if the government fails to stimulate economic growth through deeper structural reform, the local currency rating could become unsustainable,” adds Ogawa. “This, in turn, could negatively affect the outlook on the foreign currency ratings.”