DBRS Confirms BBB Rating on the Republic of India, Stable Trend

DBRS, Inc. confirmed the Republic of India’s long-term foreign and local currency issuer ratings at BBB and short-term foreign and local currency issuer ratings of R-2 (high). The trend on all ratings is Stable.

The ratings are supported by DBRS’s assessment that structural factors of the Indian economy – high domestic savings and favorable demographics – underpin the country’s strong growth potential. High growth and low real interest rates are likely to support sustainable public debt dynamics over the medium term. Exchange rate flexibility and a relatively low level of external debt also reduce external vulnerabilities. These underlying strengths are balanced by several challenges, including India’s large fiscal deficit, underdeveloped infrastructure, and asset quality concerns of the banking sector.

The Stable trend reflects the improvement in policy making, including measures that DBRS expects will foster a favorable environment for medium-term growth and fiscal consolidation. In addition to executive reforms, 2016 has seen the passage of significant legislative reforms including the Goods and Services Tax (GST) and the Insolvency and Bankruptcy Code. Both reflect the government’s ability to coordinate with the opposition parties. In addition, the statutory backing to the RBI Act has strengthened the monetary policy framework.

India’s ratings are underpinned by several fundamental strengths. India is one of the fastest growing economies in the world, with real GDP expanding at an average annual rate of 7% over the last two decades. According to the IMF, the economy is expected to expand 7.6% in FY17 and 7.7% in FY18. High domestic savings, driven by rising incomes and an increase in the working age-population ratio, have spurred economic growth. The positive outlook for capital and labor inputs, combined with the potential for technology absorption, suggest India’s long-term growth prospects remain strong.

Contrary to expectations of limited reforms on the legislative front, 2016 has seen the highest percentage of bills introduced and passed in parliament in the last few years. Key reforms include the GST Act, the Insolvency and Bankruptcy Code, the Aadhaar Act, the Real Estate Act and the Amendment of the RBI Act. While the reforms are not likely to have an immediate impact, they bode well for structural changes to the Indian economy. The continuation of executive and legislative reforms by the Modi government, and measures taken by the RBI to strengthen the monetary and banking framework, could boost trend growth higher. The government expects the implementation of GST alone is likely to boost growth by 0.9%-1.7% over the medium term.

Favorable debt dynamics and the composition of India’s public debt also support the ratings. The growth-interest rate differential more than offsets the primary deficit, which results in the baseline for debt projections declining over the forecast period to 59.2% of GDP in 2021. India’s public debt profile is characterized by its long maturity structure (10.5 years), fixed interest rates and low external debt (6% of GDP), most of which is on concessionary terms from multilateral and bilateral lenders. These factors reduce the sensitivity of the debt stock to liquidity, interest rate and exchange rate risks.

India is also relatively well-positioned to manage external volatility. While recent US election results could result in global uncertainty, on-going reforms have contained India’s current account deficit to 1% of GDP. Further, FDI inflows fully cover the external gap. In the event of an adverse shock, exchange rate flexibility and reserves totaling $367 billion can act as buffers. Consequently, from being labelled as one of the “Fragile Five” in 2013, the macro-stabilization led by the rebalancing of India’s external account and fiscal and monetary normalization could result in India being relatively less impacted in times of global volatility.

However, India’s credit profile is characterized by several challenges. India’s fiscal space has historically been limited by its low revenue base and high non-discretionary expenditures, resulting in an average general government deficit of 7.5% of GDP during the last two decades. But, its recent deficit reduction strategy has focused on raising revenues and increasing the efficiency of expenditures. On the revenue front, the passage of GST is significant, and will positively impact growth and tax revenues. Expenditure reforms include creating fiscal space by reducing subsidies, although the recommendations of the recent pay commission could keep near term deficits elevated.

In the banking sector, the high level of stressed assets and related capital requirements presents a concern, with the sum of nonperforming and restructured loans amounting to 11.5% of gross advances as of March 2016. While asset quality recognition risks remain in large infrastructure/steel projects, the share of stressed assets appears to have peaked. This peaking is due to a combination of a gradual economic recovery, some recovery of commodity prices, and recent measures taken by the RBI and the government, including the passage of the Insolvency and Bankruptcy Code. Notwithstanding concerns over profitability, Indian banks remain well-capitalized, thereby limiting macro-stability risks. Furthermore, recent de-monetization measures to fight unaccounted income bodes well for increasing financial inclusion and tax revenues.

Weak job growth and inadequate infrastructure are also major challenges. The 2016-17 Global Competitiveness Report ranks India 68th out of 140 countries in terms of overall infrastructure. While India’s rank is a 13 point improvement from the 2015-16 survey and reflects some states taking the initiative to modernize and simplify land and labor regulations, the low ranking still illustrates weak factor market outcomes.

RATING DRIVERS

The ratings could be upgraded, if there is timely and effective implementation of reforms, most notably on the Goods and Services Tax and Insolvency and Bankruptcy Code. Further continued fiscal consolidation would also be credit positive. Conversely, the ratings could come under negative pressure, if the political commitment towards reform and deficit reduction wanes, and economic growth materially underperforms.

Notes:
All figures are in US 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. These can be found at http://www.dbrs.com/about/methodologies.

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

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities.

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: Rohini Malkani
Rating Committee Chair: Roger Lister
Initial Rating Date: June 26, 2007
Most Recent Rating Update: November 5, 2015

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