What Fitch Says Can Prompt A Sovereign Ratings Downgrade For India

Days after cutting the outlook on India’s sovereign rating to negative, Fitch Ratings Inc. said that poor growth and a failure to pare government debt after the Covid-19 pandemic could prompt a downgrade. A cut in rating would mean that India would lose its investment grade status.

A structurally weak outlook for real GDP growth, for instance, due to continued financial sector weakness or poor implementation of reforms could result in a downgrade, Thomas Rookmaaker, director for sovereign ratings at Fitch Ratings, said during a webinar. Failure to reduce fiscal deficit after the pandemic recedes and to put the general government debt-to-GDP ratio on a sustained downward trajectory is another factor in a final decision on a rating change, he said.

The comments come after the rating agency revised India’s long-term outlook to negative from stable. It had affirmed the country’s rating at ‘BBB-’.

Fitch forecasts India’s GDP to contract 5% in the fiscal ending March 2021 and expects growth to rebound to 9.5% the next year, largely led by a low base effect. Also, the nation’s general government debt stood at 70% of GDP in 2019-20, well above the ‘BBB’ median of 42%. Fitch expects it to rise to 84% of GDP in the ongoing fiscal, up from a forecast of 71% in December. The forecasts are based on Fitch’s expectation of slower economic growth in 2020-21 and wider fiscal deficits, assuming that the government’s fiscal response remains restrained.

Even before the pandemic, fiscal finances were the “Achilles’ heel” in India’s credit profile, given the already high debt burden going into the crisis and limited fiscal consolidation. The financial matrix has significantly deteriorated since, notwithstanding the expenditure restraint the government has shown so far, he said.

One key question is to what extent the financial sector will be scarred by the pandemic and to what extent India will be able to facilitate higher credit growth and hence, GDP growth, in the medium term, Rookmaaker said. “We will come to know of the situation of the financial sector after the moratorium is lifted.”

Still, India’s GDP growth can outpace that of other ‘BBB’-category peers, provided the South Asian nation avoids further deterioration in health of the financial sector.

After the pandemic recedes, GDP growth in the medium term is of particular importance to achieve a downward trajectory of public debt to GDP, Rookmaaker said. That’s important from a ratings perspective. It’s interesting that Indian authorities have announced reforms for growth. While some of these measures could be transformative, the outcome depends on the details of the reforms which aren’t out yet, he said.

The ratings agency also expects that more fiscal stimulus may be in the offing. “We have factored in a larger stimulus package of about 1% of GDP more, not just the fiscal measures announced so far. PM Modi had announced 10% [of GDP] worth of measures. But of those announced, 9% weren’t fiscal in nature,” said Rookmaaker.

There was an announcement of borrowing requirements of the government, that was 2 percentage points of the GDP. That, too, could give an indication of further measures likely to be announced in the months ahead, he said.

Besides, the implementation of a credible strategy to reduce general government debt after the pandemic, higher sustained investment and growth rates in the medium term without creating macroeconomic imbalances can lead to positive rating action, Fitch said.

India’s credit profile is strengthened by relative external resilience stemming from solid foreign exchange reserve buffers, but weakened by some lagging structural factors, including governance indicators and GDP per capita, Fitch said.

While the recent situation at the border with China won’t impact credit profile immediately, the question is to what extent the government will be distracted by the current happenings, Rookmaaker said. “That’s one way to look at it,” he said, referring to the government’s agenda to push reforms.