Morningstar DBRS Changes Trend on India to Positive, Confirms at BBB (low)
SovereignsDBRS, Inc. (Morningstar DBRS) confirmed the Republic of India's Long-Term Foreign and Local Currency - Issuer Ratings at BBB (low). At the same time, Morningstar DBRS confirmed the Republic of India's Short-Term Foreign and Local Currency - Issuer Ratings at R-2 (middle). The trend on all ratings has been changed to Positive from Stable.
KEY CREDIT RATING CONSIDERATIONS
The Positive trend reflects Morningstar DBRS's view that the cumulative and ongoing benefits of India's structural reform efforts look likely to lift India's potential growth rate and facilitate fiscal consolidation. The successful implementation of reforms coupled with infrastructure investment has outperformed our expectations, driving India's macroeconomic stabilization and rapid recovery following the 5.8% pandemic-led contraction. Since then, GDP growth has averaged 8.1% during FY22 to FY24, with the IMF's April 2024 World Economic Outlook projecting that India will remain one of the world's fastest growing economies through the end of the decade. In addition to reforms implemented over the last 4-5 years including the Goods & Services Tax, lower corporate taxes, and the Insolvency and Bankruptcy Code, the economy has undergone a period of rapid digitalization and the country has significantly expanded and improved its physical infrastructure, including roads, railways, airports, and seaports. From a cyclical perspective, the country's macroeconomic balances look healthy. Inflation has returned to the Reserve Bank of India's (RBI) tolerance band of 4±2 percent. Sizable external buffers and a sound policy framework have helped the economy navigate challenging global conditions. Furthermore, Indian banks are in a strong position to support growth, with the ratio of non-performing loans-to-total loans falling to its lowest level in 8 years.
The confirmation of the BBB (low) credit rating balances India's public finance challenges with the economy's high growth potential. Perennially large fiscal deficits and elevated government debt levels characterize India's credit profile. On a general government basis, the public debt-to-GDP ratio has moderated since the shock of the pandemic but remains high at 82.7%. On the other hand, structural factors of the economy, such as relatively high domestic savings and favorable demographics, continue to underpin the country's high growth potential. India's well-regulated financial system, credible inflation-targeting regime, and flexible exchange rate also enhance the economy's resilience to shocks.
CREDIT RATING DRIVERS
The credit ratings could be upgraded if: (1) there is greater evidence that execution of policy reforms has improved medium-term growth prospects, and (2) public debt-to-GDP remains on a downward trajectory.
The credit 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. The trend could also return to Stable if reforms falter, the fiscal consolidation plan materially underperforms, or external shocks weaken India's growth prospects.
CREDIT RATING RATIONALE
India's Ongoing Physical and Digital Infrastructure Build Out Bodes Well for Its Growth Prospects
The Indian economy recovered from the pandemic over the last three years. After contracting 5.8% in FY 2020-21 (April 20 to March 21), the economy expanded by 9.7% in FY22, 7.0% in FY23, and 7.6% in FY24. The government's capex push, improvement in private consumption and an improving global environment have all contributed India's recovery. The IMF expects the India to remain amongst the fastest growing major economies in 2023-24, backed by strong domestic drivers. The IMF also expects India to grow by 6.8% in 2024 and 6.5% in 2025, higher than its earlier estimates of 6.3% for both years. Estimates by the Reserve Bank of India (RBI) are slightly higher at 7.0% in FY25.
While the near-term outlook is clouded by external risks (i.e. financing conditions, geo-political tensions, etc.), India's favorable demographics, high savings, and potential catch-up in technological capabilities suggest that India's medium-term growth prospects remain strong. Supporting this are the efforts taken by the government to improve the investment climate and continue to build out both physical and digital infrastructure. Some of these efforts include the implementation of the Goods & Services Tax, lowering of corporate tax rates, the Insolvency and Bankruptcy Code, the simplification of labor laws, and the introduction of the Production Linked Incentive (PLI) schemes. The PLI schemes gives incentives/tax breaks to domestic and global companies on incremental sales from products manufactured in India, thus providing a boost to manufacturing and employment.
The government has ramped up the country's physical infrastructure capacity in recent years, focusing on the construction of roads, railways, airports and seaports. This has been driven by increased government capital expenditure, along with the launch of the PM Gati Shakti - a digital platform connecting various ministries with the purpose of increasing coordination and efficiencies while planning and implementing infrastructure connectivity projects. Due to these initiatives, over the course of the last 8 years the length of national highways has increased almost 50%, from 97,991 km in FY15 to 146,145 km as of November 2023. Similarly, the length of electrified rail route has more than doubled from 22,224km to 60,814 km. In this same period, the number of airports has also more than doubled, from 74 to 149, and cargo handled at ports grew from 581 in FY15 million tons to 818 million tons in FY24. The cumulative and ongoing effects of these reforms coupled with the reorganization of global supply chains bodes 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% in 2024. This coupled with the Unified Payments Interface (UPI), a public platform for digitalizing retail payments, has exponentially increased the volume of digital payments. Backed by sound regulation, India's digitalization push across banking and financial services, commerce, logistics, and healthcare is transforming India from an inefficient and informal cash economy toward a more electronic, efficient and formal economy. The continuation of these trends could strengthen India's fiscal accounts and help sustain the country's relatively strong growth outlook. Please see India's Rapid Strides in Digitalization Bodes Well for the Fiscal Accounts and the Economy. India's strong growth prospects have a positive impact on our `Economic Structure and Performance' building block assessment.
High Deficits Remain A Credit Weakness, But Post-Pandemic Fiscal Consolidation Continues
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 Management and Policy building block. India's general government deficit (center and state), which averaged 7.2% for two decades prior to the pandemic, rose to 13.1% in FY21). 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 FY23 and 8.6% in FY24. The IMF estimates that the deficit will fall to 7.8% in FY25 and then gradually decline to 6.6% by FY29.
The central government deficit, which rose from 4.6% of GDP in FY20 to 9.2% during the pandemic, narrowed to 6.4% in FY23. While the new government will likely present its budget in July 2024, the Interim Budget announced in February maintained a path of fiscal consolidation. Buoyancy in tax collections coupled with prudent expenditure management resulted in a better-than-expected central fiscal deficit of 5.8% of GDP in FY24, relative to 6.4% in FY23. The Interim Budget also aims to reduce the deficit to 5.1% of GDP in FY25. This augurs well for the government meeting its fiscal consolidation glide path set in FY22, in which a fiscal deficit of 4.5% or below is targeted by FY26. Additionally, similar to trends over the last few years, the quality of fiscal spending is improving, with a continued focus on increasing infrastructure expenditure and reducing subsidies.
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, has helped increase tax buoyancy. On the expenditure front, the switch to direct transfers for subsidy payments and the market-based pricing of fuels has created some space for increased health and education expenditures. However, spending pressures generated by the Pay Commission on government salaries remain high. That said, following the pandemic, there has been a clear shift in the composition of government spending towards investment. Per the Interim budget, India's budgetary allocations to capital expenditure nearly doubled from 1.6% of GDP in FY19 to 3.2% of GDP in FY24. Capex as a percentage of total expenditures has risen from 13.3% in FY18 to 21.2% in FY24. Morningstar DBRS 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; Global Bond Index Inclusion Bodes Well For Dollar Inflows
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 has resulted in the debt-to-GDP ratio trending lower to 82.7% in FY23 and 82.4% in FY24. However, the weighted average cost of borrowing across all maturities remains high at 7.3%, while India's interest payments as a percentage of GDP is elevated at 5.4%, which is higher than its emerging market peers. That said, given India's growth prospects and digital measures to increase fiscal efficiency, Morningstar DBRS 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 will gradually decline to 77.5% by the end of its forecast horizon in 2029.
Despite the high public debt ratio, Morningstar DBRS believes risks to debt sustainability are relatively low. India's public debt is almost entirely denominated in local currency, and is characterized by a long maturity structure (12 years) as well as 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 requirements creates a captive domestic market for government 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.
Late last year, JP Morgan announced that effective June 2024, it will be adding Indian government bonds to its emerging markets bond index. This will result in Indian government bonds rising from 0% to a 10% overall weight in the index in monthly 1% increments, beginning in June 2024. This inclusion is expected to result in dollar inflows of about USD 20 - 30 billion, and could lower financing costs at the margin. Eventually, one could see Indian bonds being included in other global bond indexes. While the recent announcements of India's inclusion in global indexes bodes well for dollar inflows and further diversification of the investor base, increased foreign inflows could also result in FX volatility.
RBI Focused on Containing Inflation; Financial Stability Risks Contained Despite Rate Hikes
Following the uptrend in inflation in 2022 above the RBI's tolerance band of 4±2 percent, the RBI increased its policy repo rate by a cumulative 250bps, from 4.00% in April 2022 to 6.50% in February 2023. Rates have remained unchanged since then. Although headline inflation has eased from an average of 6.7% in 2022 to 5.6% in 2023, with the April 2024 inflation reading coming in at 4.8%, the RBI in its latest policy has voiced concerns on food inflation and the need to firmly anchor inflation expectations. Taking into account the moderation in commodity prices, the RBI expects CPI inflation to moderate further to 4.5% in FY25, stating that it would continue to focus on inflation till it sees a durable convergence towards its 4% 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 11.2% in March 2018 to a seven year low of 3.9% in September 2023. Banks continue to make adequate provisions resulting in capital adequacy ratios edging higher to 16.8% versus the regulatory minimum of 11.5%. 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 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 doubling to USD 645 billion since 2013. From a stock perspective, there are no major imbalances in the external accounts. While the on-going war in Ukraine and the Middle East coupled with global tightening impacted both sides of the balance of payments in 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.
While India's high dependence on crude oil imports paired with the ongoing economic recovery has resulted in a widening of its trade deficit, sustained growth in services exports and high inward remittances have partially offset the rise in the merchandise trade deficit. The IMF expects India's CAD to narrow from 1.96% in FY23 to 1.2% in FY24 and average 1.7% during 2025-2027. Further, India's gradual liberalization of the capital account has added to the pool of savings available for domestic investment. Latest data on foreign direct investment indicates that net FDI has fallen to USD 28 billion in FY23 from USD 39 billion in FY22. This is largely attributed to tighter global monetary policy resulting in lower start up inflows. External solvency and liquidity indicators have also improved and remain at moderate levels. From a stock perspective, India's net international investment position has continued to improve marginally, from -17% of GDP in FY19 to -10.7% of GDP in FY23, while India's gross external debt and short term external debt remain relatively low. This coupled with a high level of foreign exchange reserves and exchange rate flexibility provide buffers in the event of global market volatility.
Ruling NDA Coalition Projected to Remain in Power
India's 2024 first-past-the-post general elections are being held in seven phases between April 19 and June 1 with the results being released on June 4. While all voting will be on electronic voting machines, the election is being done in phases over 44 days is due to the size of the electorate (970 million) and the logistics and security needed to ensure that every eligible voter is able to cast their vote. The two main parties are the ruling Bharatiya Janta Party (BJP) led National Democratic Alliance (NDA) and Prime Minister Modi, and the opposition led Indian National Congress (INC) with its newly formed coalition, the Indian National Developmental Inclusive Alliance (INDIA). The BJP-led NDA currently has 347 seats in India's 543 seat Lok Sabha and has been in power since 2014 with opinion polls projecting it to win its third term with a majority. The government's track record and economic agenda are key factors behind the BJP's popularity.
India benefits from relatively strong democratic and legal institutions. India a multi-party democracy with an 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 deterioration in these metrics over the last few years.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
The Resource and Energy Management and Climate and Weather Risks Factors are relevant but do not affect the credit 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 credit 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$2.7k (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 credit 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 49th percentile for Voice & Accountability and in the 63rd 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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at (23 January 2024) at https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://dbrs.morningstar.com/research/432719.
Notes:
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 (6 October 2023) https://dbrs.morningstar.com/research/421590/global-methodology-for-rating-sovereign-governments. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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://dbrs.morningstar.com/about/methodologies.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit 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. Morningstar DBRS considers the information available to it for the purposes of providing this credit 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 credit rating process for this credit rating action.
Morningstar DBRS 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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