DBRS Confirms India’s Sovereign Ratings despite Higher Deficit

DBRS has today confirmed the Republic of India’s long-term foreign and local currency debt ratings at BBB (low) with Stable trends. Supporting the Stable trends are DBRS’s expectations that India will be one of the few countries that will grow this year, while low public external financing needs reduce government exposure to international market volatility.

However, there is downward pressure on the ratings because India is facing a sharp slowdown in GDP, capital outflows and a weaker currency, while a corporate accounting scandal has affected confidence and food and oil inflation last year has hurt the consumer. Elections in April-May 2009 present further short-term uncertainty. In response, the government has increased wages, pensions, subsidies and debt relief for farmers. More recently, the government introduced fiscal and monetary stimulus measures to stabilize the financial system, reinforce aggregate demand and boost business confidence. While understandable given India’s welfare needs, these measures will result in higher deficits.

“This is a concern of ours given India’s already high deficits and debt,” says Fergus McCormick, DBRS’s India analyst. “To prevent a Negative trend or downgrade, India’s central and state governments will need to reestablish a more responsible medium-term fiscal policy.” In DBRS’s view, this suggests that decisive reform of inefficient public institutions and structural corrections to public finances would be timely.

Given the severity of the global economic downturn, DBRS is willing to tolerate short-term fiscal stimulus measures in countries that are committed to medium-term fiscal discipline, even at the expense of a higher deficit. In the case of India, the government lacks flexibility to provide much in the way of fiscal stimulus, having generated a general government deficit of 5.5% of GDP and public debt-to-GDP of 79.1% last year.

“DBRS will maintain the ratings and trends at current levels until the government provides greater clarity on the direction of fiscal policy,” says Mr. McCormick. Specifically, DBRS will monitor the interim budget for the year starting April 1, 2009, to be announced in mid-February 2009, the incoming government’s 2009-10 budget, and the October 2009 Thirteenth Finance Commission, which will establish 2010-15 budget and debt guidelines.

The incoming government will need to finance not only a larger deficit, but also cut spending programs to establish a more sustainable fiscal policy. Bringing off-balance sheet items, such as subsidies, onto the central government balance sheet, reducing corporate and excise tax exemptions, and adopting rules that limit spending during economic upturns and provide flexibility during downturns, would strengthen public finances. To increase the capability of public institutions to provide services more effectively, reform or privatization of public entities is required.

Better fiscal policy would serve to crowd in investment and help create the conditions for more sustainable growth and poverty reduction. Also needed is broader access to high-quality education to generate employment for low-income workers and avoid shortages of skilled graduates for high-tech industries. India’s ability to take these difficult actions will depend, in part, on building a cohesive government.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies.

This is a Sovereign rating.