S&P upgrades India outlook

Factoring in the government's push to improve its finances and higher growth, Standard & Poor's today revised the outlook on India's sovereign credit rating to stable from negative.

At the same time, it warned that high inflation could spoil the party. The agency affirmed the 'BBB-' long-term and 'A-3' short-term sovereign credit ratings on India. The move was on expected lines, especially after the government protested against the lower outlook assigned last February, because a negative outlook is usually a precursor to a downgrade in the actual credit rating.

The uptick in the outlook is expected to help Indian companies and banks to negotiate better rates when they borrow overseas and international players looking to invest in the country.

"We believe this move is encouraging, and bodes well for the rupee, as well as FII inflows. We expect further rating action, given positive steps toward fiscal consolidation, the likelihood of implementation of GST later this year and India's favourable growth and external sector dynamics," Citi economists Rohini Malkani and Anushka Shah said in a note.

"The stable outlook reflects our view that India's fiscal consolidation at the central, state, and public enterprise levels over the next several years will likely restore the government's policy flexibility, and keep credit fundamentals commensurate with the 'BBB-' rating," S&P said in a statement issued this afternoon.

"The sovereign ratings on India could be raised, if the government continues to reduce the public sector's deficits materially," it said.

"Conversely, if the government continues its loose fiscal policy or there are policy setbacks on monetary, financial, and economic fronts that lower India's medium-term growth prospects could result in a downward pressure on the ratings," the rating agency added.

The Centre has budgeted its fiscal deficit for the next financial year at 5.5 per cent of the gross domestic product, against 6.7 per cent in the revised estimates for this year.

The Centre's deficit had soared owing to a reduction in taxes and higher spending to spur economic activity during the global downturn. Besides, pre-election announcements such as the farm debt relief and the pay commission reward added to fiscal woes.

The Centre has also prepared a roadmap for a return to the fiscal consolidation path in the coming years. Finance Minister Pranab Mukherjee has also said that he will present a paper on capping the government's debt at 68 per cent of GDP, as suggested by the 13th Finance Commission.

S&P pointed to the government decision to move to a nutrient-based fertiliser subsidy regime and an increase in the price of petrol and diesel as steps to improve the subsidy regime, a key element of the fiscal consolidation agenda.

Like the Centre, the state governments are withdrawing stimulus measures announced in late 2008 and early 2009 resulting in better deficit numbers for 2010-11.

"India's fiscal position could now begin to recover and that its economy will remain on a strong growth path. The government budget targets a general government (including central and state governments) deficit of 8.3 per cent in the fiscal year ending March 31, 2011, from 9.8 per cent in the previous fiscal year" S&P said.

The agency's analyst Takahira Ogawa said that S&P expected the Indian economy to grow by 8 per cent in 2010-11. The government has said it expected the economy to expand by 12.5 per cent on a nominal basis (including inflation). Chief Economic Advisor Kaushik Basu recently said that inflation during the next financial year would be 5 per cent. This translates into a real GDP growth of 7.5 per cent during 2010-11.

Besides, the rating agency said India's external position is resilient. It said that the ratio of gross external financing needs to current account receipts and international reserves is expected to remain stable at 77 per cent this year.

At the same time, it warned that ratings remained constrained by the high government debt burden and deficit, and India's weak fiscal profile. The consolidated debt of the Centre and state governments is estimated at 80 per cent of GDP in the current fiscal, while interest payments are likely to consume about 27 per cent of general government revenue, S&P estimated.

High inflation was the other pressure point and Ogawa said that it had the potential to derail the macroeconomic and interest rate environments. Inflation based on wholesale price index was estimated at 9.89 per cent in February and the government expects it to reach double-digit levels next month.

High inflation and a sharp recovery in economic activity are widely expected to result in an increase in policy rates when the Reserve Bank of India releases its annual policy statement next month.