DBRS Changes India’s Trend to Stable on Fiscal Progress

DBRS Inc. (DBRS) has changed the trend on the Republic of India’s long-term foreign and local currency debt ratings to Stable from Negative. The reasons for the change are progress in fiscal consolidation in the context of a strengthening policy framework, and a return to pre-crisis growth. Combined, these have continued the decline in India’s debt ratios. If these trends continue, the ratings could come under upward pressure over the coming year.

Evidence of a stronger commitment to fiscal deficit reduction came with the 2011-12 budget. Estimates indicate that the general government deficit will decline from 8.3% of GDP in 2010-11 (8.7% of GDP excluding privatisation receipts) to 5.4% of GDP in 2014-15. DBRS estimates that this effort, combined with reductions in subsides, changes in the tax code and privatisation of state assets, will reduce net general government debt from approximately 75% of GDP in 2010-11.

Several recent reform initiatives further support the ratings. The government is addressing the country’s infrastructure deficit by spending US$514 billion, or 9% of GDP, on infrastructure between 2007-2012, and an additional US$1 trillion from 2013-2017, approximately one-half of which may come from the private sector and public-private partnerships. India has liberalised petrol prices and incorporated oil, food and fertiliser bonds into the budget. A new direct tax code which could improve tax efficiency may be enacted in April 2012. Once introduced, a national identification card may in the coming years increase labour market formality, raise tax compliance and streamline subsidies and social security expenditures. A constitutional amendment was submitted to parliament in March 2011 to introduce a national goods and services tax, which could reduce cascading taxes and improve tax collection.

India’s fiscal and monetary policy response to the global credit crisis helped restore the economy to a path of higher growth. The economy has weathered the global credit crisis relatively well, and a strong private sector-led recovery has returned India’s growth rates to pre-crisis levels. The government estimates that growth over the next five years will average 9% (plus or minus 0.25%.)

However, DBRS remains especially concerned about two issues. First, India’s debt ratios are among the highest among developing economies. The government has made progress in rapidly reducing net general government debt from 81.9% of GDP in 2005-06 to 66.5% of GDP in 2010-11 (DBRS’s definition, which includes transfers and subsidies). However, among low to middle income countries – which have relatively low tax intakes – this is still high and further progress in lowering debt ratios would strengthen credit quality. Furthermore, the general government deficit was a relatively high 8.3% of GDP in 2010-11, food and fertiliser price subsidies are costly, and an estimated 33.9% of revenues went to paying interest on debt in 2011-12.

Second, India suffers from high inflation inertia and poorly anchored inflation expectations. Causes of Indian inflation appear to include high international food, energy and commodity prices, combined with domestic pressures, including little economic slack, high money supply growth, inefficiencies in agriculture and other domestic factors, which contribute to food price inflation. Tighter fiscal and monetary policies and, over time, better infrastructure and structural reforms should help to anchor inflation expectations.

Upward pressure on the ratings depends on adherence to fiscal targets and progress on structural reforms. If deficit-reduction stalls, DBRS is likely to maintain a Stable trend. Overall, India has adopted a more responsible medium-term fiscal policy and commitment to debt reduction, and this bodes well for the ratings.

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

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

The sources of information used for this rating include Ministry of Finance, RBI, Economic Advisory Council to the Prime Minister, Planning Commission, and the IMF. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Fergus McCormick
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 26 June 2007
Most Recent Rating Update: 13 October 2009

For additional information on this rating please refer to the linking document located below.