DBRS Confirms India at BBB (low), Trend Changed to Positive

DBRS, Inc. (DBRS) has confirmed the Republic of India’s long-term foreign and local currency issuer ratings at BBB (low) and short-term foreign and local currency issuer ratings at R-2 (middle). The trend has been changed from Stable to Positive on all ratings.

The rating confirmation reflects DBRS’s assessment that structural factors of the Indian economy – high domestic savings and favorable demographics – underpin the country’s strong growth prospects. High growth and low real interest rates are likely to support improving public debt dynamics over the medium term. Exchange rate flexibility and a relatively low level of external debt enhance the economy’s resilience to shocks, providing further support to the ratings. These underlying strengths are balanced by several challenges, including India’s large fiscal deficit, underdeveloped infrastructure and rigid market regulation.

The change in trend reflects positive developments on three fronts. First, macroeconomic policymaking is improving. The government is committed to fiscal consolidation by rationalizing expenditure and advancing tax reform, and the Reserve Bank of India aims to anchor price stability with a transparent monetary framework. These measures could help foster a favorable environment for balanced growth. Second, the government is taking administrative steps to improve the investment climate. This includes simplifying business regulation, streamlining government decision-making, and amending financial sector regulations to make the system more efficient and flexible. Cumulatively, these micro reforms could help alleviate supply-side bottlenecks and boost market sentiment. Third, the landside BJP victory in the May 2014 general elections puts the government in a strong position to implement much-needed market reforms.

The ratings could be upgraded if fiscal consolidation advances and a durable economic recovery – supported by an improving investment outlook – takes hold. On the other hand, if the political commitment to reduce the fiscal deficit weakens or structural bottlenecks are not adequately addressed as expected, the trends could be changed back to Stable.

India’s ratings are underpinned by several fundamental strengths. India has been one of the fastest growing economies in the world and, notwithstanding the recent slowdown, growth prospects remain strong. Real GDP expanded at an annual average rate of 7.5% over the last decade. Higher private savings, driven by rising incomes and an increase in the working age-population ratio, have supported higher rates of investment and spurred faster growth. Favorable demographics, high savings and potential catch-up in technological know-how suggest that India’s long-term growth prospects remain strong.

The favorable composition of India’s public debt profile also support the ratings. The average maturity of outstanding central government securities was 10.2 years in June 2014 and nearly all issuance is at fixed rates. External general government debt totals just 4.3% of GDP, and of this amount, most is on concessionary terms at long maturities from multilateral or bilateral lenders. The government is able to finance large fiscal deficits on favorable terms due to the large pool of domestic savings, coupled with financial regulations that require commercial banks and other institutional investors to hold public securities. Although this arrangement leads to an inefficient intermediation of savings and thereby lowers potential GDP, the public sector benefits from better terms and reduced rollover risk.

Rising geopolitical tensions and tighter global financing conditions as the U.S. Federal Reserve normalizes monetary policy pose downside risks to the near-term outlook. However, India appears relatively well-positioned to manage volatility in the external markets. The current account deficit has narrowed markedly over the last year and the mix of external financing has improved. In the event of an adverse shock, exchange rate flexibility and international reserves totaling $314 billion provide significant buffers. Moreover, the recent decline in international oil prices is equivalent to a positive terms-of-trade shock for India, with positive effects on economic growth, public finances and the external balance.

However, India’s credit profile is characterized by several significant challenges. Persistently large fiscal deficits since the onset of the global financial crisis have contributed to inflationary pressures and lowered public savings. Rising subsidy costs have created large economic inefficiencies and diverted scarce resources away from public investment. Over the last two years, the government has made progress reducing the deficit, and the recent decision to decontrol diesel prices should help reduce the subsidy bill. However, spending pressures generated by expanding entitlement programs could put pressure on public finances over the medium term if they are not accompanied by revenue-boosting reforms.

Inadequate infrastructure is also a major challenge. According to the 2014-15 Global Competitiveness Report by the World Economic Forum, India ranks 90th out of 144 countries in terms of the quality of overall infrastructure. Efforts to upgrade the country’s infrastructure have been impeded by land acquisition problems, the slow delivery of environmental clearances and financing difficulties. If unaddressed, poor infrastructure could constrain economic growth.

While the Modi government has taken administrative measures to revive stalled investment projects, sustaining high rates of growth over the medium term will likely require market reforms. Structural weaknesses in key markets, such as power and food, dampen productivity and distort the allocation of factor resources. In particular, bottlenecks in domestic coal supply hamper the energy sector, despite ample reserves and generation capacity. Restrictive labor regulations hinder India’s ability to fully benefit from its comparative advantage in the production of labor-intensive goods, with negative effects on productivity and employment. Addressing structural deficiencies in these markets in a comprehensive manner will require legislation.

Notes:

All figures are in U.S. Dollars unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include the Reserve Bank of India, Ministry of Finance, Central Statistics Organization India, IMF, Bloomberg, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Michael Heydt
Rating Committee Chair: Roger Lister
Initial Rating Date: 26 June 2007
Most Recent Rating Update: 30 September 2013

For additional information on this rating, please refer to the linking document under Related Research.