DBRS, Inc. (DBRS Morningstar) confirmed the Republic of India’s Long-Term Foreign and Local Currency – Issuer Ratings at BBB (low). At the same time, DBRS Morningstar confirmed the Republic of India’s Short-Term Foreign and Local Currency – Issuer Ratings at R-2 (middle). The trend on all ratings is Stable.
KEY RATING CONSIDERATIONS
The Stable trend reflects DBRS Morningstar’s expectation that despite the deterioration in the global environment due to rising commodity prices and tightening financial conditions, India’s strong external buffers and policy framework should help preserve macroeconomic stability and support the economic recovery. While India’s near-term growth prospects are buoyed by the economic reopening and a favorable monsoon outlook, the spillover effects of higher commodity prices, global supply side disruptions, and tightening financing conditions pose downside risks. Following GDP growth of 8.9% in FY22 (April 2021- March 2022), the Reserve Bank of India (RBI) projects growth of 7.2% for FY23, slightly below the IMF’s World Economic Outlook’s estimate of 8.2%.
India’s BBB (low) rating balances India’s high potential growth rate with public finance challenges. In the two years since the start of the pandemic, India’s general government deficit has remained above 10% of GDP, while India’s already high stock of public debt increased from 75.1% of GDP in FY20 to 90.1% of GDP in FY21. The IMF projects debt-to-GDP will remain stable at about 87% through 2023 and then begin to gradually decline as the fiscal accounts consolidate. Higher debt is translating into higher interest costs, despite lower rates. At 5.4% of GDP, India’s interest payments are higher than most of its emerging market peers. That said, structural factors of the economy, such as relatively high domestic savings and favorable demographics, continue to underpin the country’s high growth potential. The economy has demonstrated a high degree of resilience in recent years, due in large part to a well-regulated financial system, a credible inflation-targeting regime, and a flexible exchange rate. Further, on-going reform measures to improve the investment climate bode well for India’s medium term growth potential.
The ratings could be upgraded if: (1) the public debt ratio is placed on a firm downward trajectory, or (2) if the execution of policy reforms significantly improves economy-wide productivity growth. The ratings could be downgraded if (1) the debt-to-GDP ratio materially increases over the medium term, or (2) if there is a weakening in the country’s macroeconomic policy framework.
Global Developments Could Impact Near Term Growth But Medium Term Prospects Stay Strong
The Indian economy is steadily recovering from the pandemic. Following a contraction of 6.6% in FY21 (April 2020-March 2021), real GDP is estimated to have risen by 8.9% in FY22. The recovery now appears broad-based with high frequency data, including both manufacturing and services PMI in expansion. That said, external developments could take a toll on the growth momentum. Although India’s direct trade exposure to Russia and Ukraine is limited, the evolving global environment could impact the recovery through several channels. First, higher commodity prices are contributing to higher inflation and trade deficits. Second, policy normalization in advanced economies is leading to tightening financial conditions globally. Third, renewed COVID-19 infections in China and the continuation of its zero covid strategy could prolong supply chain disruptions. The RBI recently revised India’s FY23 growth forecast from 7.8% to 7.2%, and risks remain skewed to the downside.
While external developments have clouded the near-term outlook, India’s favorable demographics, relatively high savings, and potential catch-up in technological know-how suggest that India’s medium-term growth prospects remain strong. The government has been tackling some of the structural issues to improve the investment climate. This includes simplifying business regulation, enacting the Insolvency and Bankruptcy Code, easing restrictions on foreign direct investment, introducing the Goods & Services Tax and reducing corporate tax rates. Furthermore, the creation of the Jan Dhan–Aadhar–Mobile (JAM) trinity which links bank accounts, Aadhar IDs and mobile numbers has increased financial inclusion. In addition to stimulus measures to support the economy, the pandemic also resulted in the government enacting further structural reforms aimed at simplifying labor laws, liberalizing FDI and maximizing India’s core competency in various sectors via the Production Linked Incentive (PLI) scheme. The PLI scheme gives incentives to domestic and global companies on incremental sales from products manufactured in India, which in addition to attracting investments, provides a boost to manufacturing and employment. As a result, India’s growth prospects have a positive impact on the ‘Economic Structure and Performance’ building block assessment.
India’s Fiscal Position Sees Some Consolidation, But Remains A Credit Weakness
India’s fiscal space has historically been limited by its low revenue base and high non-discretionary expenditures. In addition to structural challenges in central government finances, state deficits have been averaging 3% of GDP. As a result, the general government deficit averaged 7.5% of GDP over the last two decades. The global pandemic weighed heavily on India’s public finances, with the center’s budget deficit rising from 4.6% in FY20 (April 2019 to March 2020) to 9.2% of GDP in FY21, and the overall general government deficit increasing to 12.7% of GDP in FY21.
The economic recovery and unwinding of the pandemic measures resulted in the central government deficit narrowing to 6.9% of GDP in FY22. This year, the deficit is expected to decline to 6.4%, and thereafter a gradual fiscal consolidation of 0.5% each year until reaching 4.5% of GDP in FY26. Although the headline deficit is expected to narrow, the shift in the composition of spending towards investment should be supportive of the recovery and longer-term growth. While overall expenditures (15.3% of GDP) are budgeted to increase by 4.6% YoY, a breakdown indicates a 0.9% YoY increase in revenue expenditure (phasing out of the pandemic related measures) while capital expenditures are budgeted to increase 24.5% YoY. The continuation of capex driven growth bodes well for strengthening India’s post-pandemic economic recovery. While the impact of global spillovers could result in higher expenditures – primarily through food and fertilizer subsidies, slippages are expected to be minimal, especially as the budget estimates are conservative. The budget assumes a nominal GDP growth rate of 11.1%, with overall revenue receipts budgeted to rise 6.0% (also in nominal terms).
While India’s weak public finances remains a key credit constraint, the government has been taking measures to raise revenues and increase the efficiency of expenditures. Measures to improve the revenue base include the successful implementation of the Goods and Services Tax Bill (GST). This along with progress on rationalization of tax rates, financial inclusion and digitalization, is positive and has helped increase tax buoyancy. On the expenditure front, while savings from market-based pricing of fuels and the switch to direct transfers for subsidy payment have created some space for increased health and education expenditures, they have been partially offset by spending pressures generated by the Pay Commission on government salaries.
Public Debt Levels Are High But Risks to Debt Sustainability Are Limited
The large fiscal deficits combined with weak growth during the pandemic have led to a higher level of government debt in India. The IMF estimates that India’s general government debt ratio increased from 75.1% in FY20 to 90.1% in FY21 before stabilizing at 86.7% in FY22. While the weighted average cost of borrowing across all maturities has trended down to 6% currently, India’s interest payments as a percentage of GDP at 5.4% is higher than its emerging market peers. DBRS Morningstar expects only a gradual repair to public finances in the coming years. In its latest World Economic Outlook, the IMF expects India’s public debt-to-GDP ratio to gradually fall from 86.7% in FY22 to 84.7% in FY27.
Despite the deterioration in the credit metrics, DBRS Morningstar sees limited risks to debt sustainability given India’s medium term growth prospects and low real rates. In addition, India’s public debt profile is characterized by its long maturity structure (10.5 years), fixed interest rates, and marginal external debt (1.8% of GDP), most of which is on concessionary terms from multilateral and bilateral lenders. Moreover, the statutory liquidity requirement creates a captive domestic market for debt. At the same time, limits on foreign portfolio investments in government bonds are being increased incrementally, thereby expanding the pool of funds for government securities and diversifying the investor base.
RBI Continues to Support Growth But Focus Now Shifts to Containing Inflation
India’s monetary policy is beginning to normalize as inflationary concerns rise to the fore. The RBI announced several conventional and unconventional measures to support the economy and maintain liquidity in the financial system as a result of the pandemic. These measures eased domestic financial conditions and helped stabilize growth. However, the spillover impacts of the Russian invasion of Ukraine in February 2022 coupled with ongoing COVID-19 concerns have resulted in the materialization of downside risks to growth and upside risks to inflation, with the March 2022 inflation reading coming in at 6.9%. Consequently, in its April 2022 monetary policy committee meeting, the RBI revised its FY23 inflation forecast higher to 5.7% from 4.5%, while simultaneously revising down its growth forecast to 7.2% from 7.8%. Concerns of inflation remaining higher than target (4%, with a tolerance band of 2%) have resulted in the RBI beginning to withdraw monetary policy support. In its April 2022 policy meeting, the RBI restored the liquidity management framework instituted in February 2020. Further, in a surprise inter-meeting move on May 3, 2022, the RBI raised its policy rate by 40bp to 4.4% and the Cash Reserve Ratio (CRR) by 50bp to 4.5%. With this, the RBI reverted to its pre-pandemic 50bps liquidity adjustment facility (LAF) corridor around the policy rate. With headline inflation inching higher in April at 7.79%, more rate hikes are expected in the coming months.
On the financial stability front, the economic recovery and RBI infused liquidity measures have eased prior stresses in the financial sector. On the assets side, thanks to the resolution and recovery of assets under the reformed Insolvency and Bankruptcy Code, the downward trend in non-performing assets continued with NPLs falling further from a peak of 11.5% in March 2018 to 6.9% in September 2021. Banks continue to make adequate provisions resulting in capital adequacy ratios edging higher to 16.6%. Moreover, the RBI in its latest Financial Stability Report stated that while its stress tests indicated that NPLs could rise to 9.5% in September 2022 under a severe stress scenario, banks have sufficient capital, both at the aggregate and individual levels.
India’s External Position Acts as a Buffer to Changes in Risk Appetite
India’s external accounts are healthy and have improved significantly since the taper-tantrum episode in 2013. The current account deficit has averaged 1.1% for the last seven years. Low current account deficits and buoyant capital flows have resulted in India’s forex reserves doubling to USD 600 billion since 2013. The war in Ukraine coupled with tightening global financial conditions are likely to impact both sides of India’s balance of payments, including higher deficits and lower flows to emerging markets. Nonetheless, the improvement in external buffers since 2013 and the strengthening of the financial sector will likely help mitigate any stress.
India’s current account deficit is likely to widen in 2022 but DBRS Morningstar sees limited risks to macroeconomic stability. The sharp escalation in international commodity prices, along with India’s heavy dependance on crude oil imports, has led to a strong rebound in imports and in a widening of the trade and current account deficits. That said, sustained growth in services exports and inward remittances are likely to partially offset the rise in the merchandise trade deficit. Moreover, we expect FDI inflows to broadly cover the current account deficit. India’s gradual liberalization of the capital account has added to the pool of savings available for domestic investment, although tighter global financial conditions run the risk of dampening capital inflows into emerging markets. The government’s strategy on FDI flows has facilitated technology spillovers and improved the quality of the capital account. External solvency and liquidity indicators have also marginally improved and remain at moderate levels. India’s net international investment position has remained stable at -12% of GDP in FY22, while India’s gross external debt and short term external debt remain relatively low.
Institutional Strength And Policy Continuity Are Credit Positives
Given India’s democratic and legal institutions, India compares favorably to other lower-middle income countries in terms of the World Bank’s Voice and Accountability and Rule of Law indicators. Furthermore, a vibrant press and active civil society support India’s democracy. Policy measures enacted over the last few years on improving the governance framework and the business environment have improved the ease of doing business in India. The recent launch of the PM Gati Shakti – the digital platform connecting various ministries for planning and coordinated implementation of infrastructure connectivity projects bodes well for a further improvement in the business environment. The Bharatiya Janta Party (BJP) led by Prime Minister Modi has been in power since 2014. While general elections won’t be held in India until 2024, recent state election results bode well for policy continuity and stability.
Human Capital & Human Rights (S), Access to Basic Services (S), Bribery, Corruption & Political Risks (G), were among key drivers behind this rating action. India’s balance of payments and public finances are vulnerable to oil price shocks as India imports 70% of its crude oil requirements. Agriculture and allied activities account for 18% of the economy and directly and indirectly accounts for close to 60% of employment. However, with 45% of the area under cultivation irrigated, most of the arable land is dependent on the vagaries of the monsoon. Similar to other emerging market economies and many of its regional peers, India’s 2021 GDP per capita is low at USD 2.3k (USD 7.3k on a PPP basis), reflecting low levels of productivity. According to World Bank Governance Indicators, India ranks in the 47th percentile for Control of Corruption, the 54th percentile for Rule of Law, the 53rd percentile for Voice & Accountability and in the 67th percentile for Government Effectiveness. While there have been occasional peace talks, border skirmishes along Jammu & Kashmir in the North West and Arunachal Pradesh in the North East with both Pakistan and China have contributed to India’s low (17th percentile) rank for the Political Stability and Absence of Violence/Terrorism indicator. India has also suffered periodically from sectarian tensions. These considerations have been taken into account within the following Building Blocks: Fiscal Management and Policy, Economic Structure and Performance, and Political Environment.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/397087.
All figures are in USD unless otherwise noted. Public finance statistics reported on a general government basis unless specified.
The principal methodology is the Global Methodology for Rating Sovereign Governments https://www.dbrsmorningstar.com/research/381451/global-methodology-for-rating-sovereign-governments (July 9, 2021). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).
Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.
The primary sources of information used for this rating include Ministry of Finance, Reserve Bank of India, Central Statistical Organization, Ministry of Health and Family Welfare, UIDAI, NREGA, PMJDY, IMF, BIS, World Bank, United Nations’ Gender Inequality Index and Haver Analytics. DBRS Morningstar 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 for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
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