DBRS Assigns Negative Trends to India’s Ratings on Medium-Term Fiscal Uncertainty

DBRS has today changed the trends on the Republic of India’s long-term foreign and local currency BBB (low) debt ratings to Negative from Stable. This action reflects DBRS’s discomfort with India’s high deficit, combined with ongoing uncertainty over how the government intends to reduce the deficit in the coming years. DBRS recognizes that fiscal and monetary stimulus measures have been warranted to counter the effects of the international financial crisis on the Indian economy, and that premature withdrawal of these measures should be avoided. However, at close to 10% of GDP, the size of the deficit calls for a clearer roadmap on how the government intends to return to a more sustainable fiscal stance once the economic recovery arrives.

During the May 2009 elections, the government-led coalition won a larger majority. This should facilitate the approval of measures to reestablish a framework for fiscal policy, address underlying causes of the deficit and adopt a medium-term plan for reducing public debt. Nonetheless, DBRS will await the April 2009-10 budget and 2010-2015 medium-term guidelines by the Thirteenth Finance Commission for signs of an improvement in the country’s fiscal stance. Implementation of corrective measures that seek to constrain expenditures within reasonable revenue assumptions would likely trigger a return to Stable trends. However, once it is clear that economic recovery has arrived, a continuation of fiscal easing would result in downward pressure on the ratings.

DBRS has expressed concern about India’s deficit since June 2007. During its last review in February 2009, DBRS stated that given the severity of the global financial crisis, it was willing to tolerate short-term fiscal stimulus measures in countries committed to medium-term fiscal discipline, even at the expense of a higher deficit, and for as long as the crisis lasted. However, DBRS also stated that to avoid a Negative trend, India would need to reestablish a more responsible medium-term fiscal policy. The good news is that prior to 2008-09, Indian central and state governments demonstrated a firm commitment to reduce the general government deficit from 10.1% of GDP in 2001-02 to 5% of GDP in 2007-08. Yet recent spending was unaccompanied by a plan to return to fiscal consolidation. Official estimates expect the central government deficit to increase from 2.7% of GDP in 2007-08 to 6.8% in 2009-10, and the general government deficit to increase from 5% of GDP in 2007-08 to 10.2% in 2009-10. The consolidated deficit, including off-balance sheet items, is even higher. Net general government debt is expected to rise from 73.1% of GDP in 2008-09 to 75.4% in 2009-10.

Many countries have provided fiscal and monetary stimulus to counter the global financial crisis. However, DBRS is especially concerned about India for two reasons. First, India entered the crisis with relatively high public debt, and this should have constrained the degree of fiscal easing. An absence of binding deficit, debt or expenditure rules allowed for extraordinary spending, including an agricultural loan write-off, a large wage hike for civil servants, and an increase in food, fertilizer and oil subsidies, some of which were off-budget. Second, these extraordinary measures were increased even before the global financial crisis deepened in September 2008. While the subsidies may have been lifted to cushion a rise in domestic prices due to higher global commodity prices, these came prior to the economic stimulus measures the government provided in December 2008 and January 2009 to counter the decline in domestic demand.

There are signs that the government may submit a 2010-11 budget that targets a deficit of 5.5% of GDP and a deficit of 4% of GDP in 2011-12, as per the Finance Minister’s 2009-10 Union Budget Speech and the Medium Term Fiscal Policy Statement presented to Parliament. The Thirteenth Finance Commission, which will set fiscal and debt guidelines from 2010 to 2015, possibly within the context of a new Fiscal Responsibility and Budget Management Act (FRBMA), may incorporate off-balance sheet items onto the budget balance sheet, and introduce a new debt-targeting or expenditure-targeting framework. If implemented, these motions would underscore an intention to improve the medium-term fiscal stance. DBRS would draw greater comfort once it learns of the specific measures that the government will adopt in the 2010-11 budget, to be released in April 2010, and once there is evidence of adherence to possible new fiscal guidelines.

The government has also outlined several initiatives that may be introduced in the 2010-11 budget or FRBMA that, if implemented, should strengthen the fiscal framework. These include reducing subsidies and improving their effectiveness; making public enterprises more efficient by divesting shares; and deregulating petroleum prices to reduce fiscal exposure to changes in international oil prices. Two additional proposals are a new national goods and services tax and a national identification card, both of which could result in greater tax collection and formalization of the tax base in the coming years. The adoption of fiscal responsibility laws by most states is a concrete improvement.

DBRS views India’s fiscal and monetary policy response to the international financial crisis as timely and effective in helping to restore the economy on a path of higher growth. Indeed, the economy has weathered the global financial crisis relatively well, and expectations are that Indian GDP could grow by 6.5% this fiscal year and 7.5% next year. However, the introduction and adherence to a new medium-term framework for containing expenditures, reducing the deficit or targeting debt levels would provide greater predictability to fiscal policy and would help to stabilize the ratings.

DBRS considers India’s capacity and incentives to service its foreign currency securities to be the same as its local currency securities. For this reason, DBRS has maintained the ratings at the same level.

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

This is a Sovereign rating.