DBRS Morningstar Confirms India at BBB (low), Stable Trend

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 India’s resilient economic performance and ongoing structural reform efforts. The Indian economy has rapidly recovered from the pandemic. Following a contraction of 5.8% in FY21 (April 2020 to March 2021), output grew by 9.1% in FY22 and an estimated 7.0%% in FY23. The IMF projects that India will expand on average by 6.1% per year through FY25. This places India among the fastest growing major economies in the world. Despite higher commodity prices and tighter global financial conditions in 2022, India’s external buffers and sound policy framework helped preserve macroeconomic stability. Indian banks’ non-performing loans to total loans ratio declined to a 7-year low last year. Inflation has increased but trended just slightly over the RBI’s tolerance band of 4±2 percent. In addition, external accounts have adjusted well to changing global conditions and do not exhibit clear imbalances. Reforms passed over the last 4-5 years, including the Goods & Services Tax, lower corporate tax rates, and the Insolvency and Bankruptcy Code, are interacting with the rapid digitalization of the Indian economy. Taken together, these changes could potentially improve the investment climate over time and strengthen the country’s medium-term growth prospects.

The confirmation of India’s BBB (low) rating balances India’s high potential growth rate with public finance challenges. The general government deficit was elevated at 9.5% of GDP in FY23, although down from a pandemic high of 12.7% in FY21. Likewise, the public debt-to-GDP ratio has moderated since the shock of the pandemic but remains high at 83% of GDP. 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. Furthermore, 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.

RATING DRIVERS

The ratings could be upgraded if: (1) there is greater evidence that execution of policy reforms has improved medium-term growth prospects, or (2) the public debt ratio is put on a firm downward trajectory.

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.

RATING RATIONALE

Economy Remains Resilient Despite Global Challenges; Reforms and Digitalization Boosts Medium Term Prospects

Following the pandemic led-contraction of 5.8% in FY21, the Indian economy rebounded sharply by 9.1% in FY22, supported by accommodative macroeconomic policies and quick and extensive vaccine coverage. Despite supply chain disruptions, inflationary pressures, and tighter financing conditions in FY23, GDP growth remained buoyant, with GDP growth coming in at 7.0%. A strong rebound in services, the government’s capex push, and consecutive years of strong agricultural production all contributed to India’s resilience. The IMF expects India to grow at 5.9% and 6.3% in 2023 and 2024, down from its earlier estimates of 6.1% and 6.8%, respectively, largely due to downward revisions to global growth. That said, the IMF expects the Indian economy to remain amongst the fastest growing major economies in 2023-24, backed by strong domestic drivers and strengthening macroeconomic fundamentals. Estimates by the Ministry of Finance (MOF) are slightly higher at 6.0%-6.8% in 2023-24.

While the near-term outlook is clouded by external risks (i.e. financing conditions, weather-related risks, etc.), India’s favorable demographics, high savings, and potential catch-up in technological know-how suggest that India’s medium-term growth prospects remain strong. The government has also taken measures to improve the investment climate. Reforms initiated in the last few years include the implementation of the Goods & Services Tax, the lowering corporate tax rates, the introduction of the Insolvency and Bankruptcy Code, the simplification of labor laws, and the introduction of the Production Linked Incentive schemes (PLI) in various sectors. The PLI scheme gives incentives/tax breaks 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. The cumulative and ongoing effects of these reforms coupled with the reorganization of global supply chains bode well for the investment outlook.

Furthermore, India’s rapidly evolving public digital infrastructure is facilitating innovation, productivity improvements, and access to services. The Jan Dhan–Aadhar–Mobile (JAM) trinity, which links bank accounts, Aadhaar IDs, and mobile numbers, has increased financial inclusion to 80% currently. This coupled with the Unified Payments Interface (UPI), a public platform for digitalizing retail payments, has exponentially increased the volume of digital payments. The 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. India’s ongoing digitization efforts across banking and financial services, logistics, healthcare is pushing India from an inefficient and informal cash economy to a more electronic, efficient and formal economy – all of which bode well for higher productivity growth. India’s strong growth prospects have a positive impact on our assessment of the ‘Economic Structure and Performance’ building block assessment.

Post-Pandemic Fiscal Consolidation Continues, But High Deficits Remain A Credit Weakness

India’s fiscal space has historically been limited by its low revenue base and high non-discretionary expenditures, resulting in its poor score in the Fiscal Policy and Management building block. India’s general government deficit (center and state), which averaged 7.5% for two decades prior to the pandemic, rose to 12.7% in FY21 (April 20 to March 21). Since then the government has been consolidating fiscal accounts and improving transparency (e.g. food subsidies linked to the Food Corporation of India are now above the line). The economic recovery and the unwinding of pandemic measures resulted in the general government deficit narrowing to 9.6% in FY22. The IMF estimates that the deficit declined to 9.5% in FY23 and will reach 8.9% FY24. The central government deficit, which rose from 4.6% of GDP in FY20 to 9.2% during the pandemic, narrowed to 6.8% in FY22 and 6.4% in FY23. The central government deficit is expected to decline to 5.9% in FY24, and then continue on the broad glide path of fiscal consolidation to reach a fiscal deficit of 4.5% of GDP by FY26.

While India’s overall deficits and interest payments as a percentage of revenues remain higher than its peers in the BBB rating range, 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, the switch to direct transfers for subsidy payment and the market-based pricing of fuels have created some space for increased health and education expenditures. However, spending pressures generated by the Pay Commission on government salaries remain high. That said, post the pandemic, there has been a clear shift in the composition of government spending towards investment. As per the latest budget, capex as a percent of total expenditures has risen from 12% of total expenditures in FY18 to 22% of total expenditures in FY24. DBRS Morningstar sees this as credit positive as it bodes well for medium-term growth.

Public Debt Levels Are High But Risks to Debt Sustainability Are Limited

The pandemic resulted in India’s public debt-to-GDP rising from 75% of GDP in FY20 to 89% in FY21. Since then, the economic recovery and the removal of the stimulus have resulted in the debt-to-GDP ratio trending lower to 85% in FY22 and 83% FY23. While the weighted average cost of borrowing across all maturities has trended down to 6%, India’s interest payments as a percentage of GDP is elevated at 5.4%. The trajectory on public debt in the coming years will depend on the pace of economic growth and fiscal consolidation. Given India’s growth prospects and digital measures to increase fiscal efficiency, DBRS Morningstar expects a steady but gradual consolidation of fiscal accounts in the coming years. In its latest World Economic Outlook, The IMF estimates India’s general government debt ratio to stabilize at 83% over the next five years.

Despite the high public debt ratio, DBRS Morningstar believes risks to debt sustainability are relatively low. India’s public debt is almost entirely denominated in local currency, is characterized by a long maturity structure (12 years) and fixed interest rates. Public external debt is marginal at 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 government debt, even as 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 Focused on Containing Inflation; Financial Stability Risks Contained Despite Rate Hikes

The Reserve Bank of India (RBI) began normalizing monetary policy in May 2022 as inflationary concerns rose to the fore. The RBI has increased the policy repo rate cumulatively by 250bps, from 4.00% in April 2022 to 6.50% in February 2023. Rates have remained unchanged since then. Ongoing supply chain disruptions along with higher commodity prices – both food and fuel – have resulted in headline CPI inflation being at or above the RBI's tolerance band of 4±2 percent, averaging 6.6% in FY23. Going forward, taking into account the moderation in commodity prices, the RBI expects CPI inflation to decline to 5.2% in FY24. While the RBI appears to be close to the end of its current hiking cycle, it remains cautious stating that it would continue to monitor inflation till it sees a durable convergence toward its target. On the financial stability front, despite higher rates impacting global financial markets and resulting in debt distress in many frontier emerging markets, domestic financial markets have remained stable. 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 a seven year low of 5.0% in September 2022. Banks continue to make adequate provisions resulting in capital adequacy ratios edging higher to 16.0%. India’s non-banking financial sector has also withstood these challenges. The RBI in its latest Financial Stability Report indicates that banks would be able to withstand even severe stress conditions should they materialize.

India’s External Position Continues to Build Buffers; Services Exports Offset Negative Terms of Trade

India’s external accounts are healthy and have improved significantly since the taper-tantrum episode in 2013. Low current account deficits and buoyant capital flows have resulted in India’s forex reserves nearly doubling to USD 596 billion since 2013. From a stock perspective, there are no major imbalances in the external accounts. While the war in Ukraine coupled with global tightening have impacted both sides of the balance of payments in FY22 and FY23, the improvement in external buffers since 2013 and the strengthening of the financial sector have helped to mitigate stresses coming from the external sector.

India’s high dependence on crude oil imports coupled with the ongoing economic recovery resulted in the current account deficit widening to -3.7% of GDP during Q2 FY23. But lower prices since then coupled with sustained growth in services exports and high inward remittances partially offset the rise in the merchandise trade deficit, with the current account deficit narrowing to 2.2% of GDP in in Q3 FY23. The IMF expects India’s CAD to remain low averaging 2.2% during 2023-2025. Further, India’s gradual liberalization of the capital account has added to the pool of savings available for domestic investment. The government’s strategy on FDI flows has facilitated technology spillovers and improved the quality of the capital account and FDI flows broadly cover the current account. External solvency and liquidity indicators have also improved and remain at moderate levels. From a stock perspective, India’s net international investment position continues to improve marginally from -17% of GDP in FY16 to -11% of GDP in FY23, while India’s gross external debt and short term external debt remain relatively low. On the back of RBI intervention and valuation losses, headline forex reserves declined from USD 607 billion in March 2022 to USD 596 billion currently. This coupled with exchange rate flexibility provide buffers in the event of global market volatility.

Institutional Strength And Policy Continuity Are Credit Positives, But There Are Concerns

India benefits from relatively strong democratic and legal institutions. India a multi-party democracy with a vibrant press and active civil society. Compared to other lower-middle income countries, India ranks relatively well in Voice and Accountability and Rule of Law according to the Worldwide Governance Indicators. That said, there has been some erosion of these metrics over the last few years. 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, direction of reforms bode well for policy continuity and stability.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Environmental (E) Factors

The Resource and Energy Management and Climate and Weather Risks Factors are relevant but do not affect the ratings assigned to India. 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. With only 45% of the area under cultivation irrigated, most of the arable land is dependent on the vagaries of the monsoon.

Social (S) Factors

The Human Capital & Human Rights and Access to Basic Services factors affect the ratings assigned to India. Similar to other emerging market economies and many of its regional peers, India’s per capita GDP is relatively low, at US$2.4k (US$8.3k on a PPP basis). This reflects the relatively low level of labor productivity. Healthcare in India is universal but there are differences in quality of care between urban and rural areas. Additionally, rural areas often face difficulties accessing sanitation and clean drinking water.

Governance (G) Factors

Bribery, Corruption and Political Risks affect India’s ratings. According to Worldwide Governance Indicators, India ranks in the 46th percentile for Control of Corruption and in the 51.9th percentile for Rule of Law. Institutional Strength, Governance and Transparency and Peace and Security are also relevant to the ratings. India ranks in the 51st percentile for Voice & Accountability and in the 62.5th 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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/414081.

Notes:

All figures are in U.S. dollars unless otherwise noted. Public finance statistics reported on a public sector basis; this excludes state and local governments but includes state-owned enterprises and public development banks. The fiscal balance is the Public Sector Borrowing Requirement.

The principal methodology is the Global Methodology for Rating Sovereign Governments https://www.dbrsmorningstar.com/research/401817/global-methodology-for-rating-sovereign-governments (August 29, 2022). In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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.

The 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, management and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is a solicited credit rating.

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