India's pace of debt reduction leaves room for downside risk

Fitch Ratings on Monday said India's pace of debt reduction is gradual, leaving room for a downside risk to sovereign rating in the eventuality of a significant economic shock.

However, the rating agency expressed confidence in India's ability to stick to its medium-term fiscal framework, which aims to reduce debt and bring it on a downward trajectory over time.

"Increased confidence that the government can adhere to this medium-term fiscal framework and keep debt firmly on a downward path, would be positive for the sovereign rating over time.

"Still, the pace of debt reduction is gradual, which leaves open downside risks from a large economic shock," Jeremy Zook, Director and Primary Sovereign Analyst for India at Fitch Ratings, said while commenting on India's 2025 Budget.

In August 2024, Fitch affirmed India's sovereign rating at 'BBB-' with a stable outlook. India's rating has remained unchanged at 'BBB-', the lowest investment grade, since August 2006.

Zook highlighted the government's ongoing commitment to deficit reduction, even amid a slowing economic environment.

The fiscal deficit targets pegged in the budget align with Fitch's expectations, with a slightly lower FY25 target of 4.8 per cent of GDP and a FY26 target of 4.4 per cent.

He said that the projections appear realistic, and he believes the targets will be achieved.

However, he warned that modest slippages in revenue collection could occur due to slower economic growth, which may require additional expenditure restraint.

Finance Minister Nirmala Sitharaman in her Budget speech on Saturday projected the fiscal deficit for FY25 at 4.8 per cent of GDP and 4.4 per cent for FY26.

Fitch considers the budget as broadly neutral for growth, with the consumption boost from tax cuts and sustained capital expenditure likely to offset the contractionary effects of deficit reduction.

The policy focus on boosting investment through deregulation is expected to have a positive impact on medium-term growth, but its success will depend on the effective implementation of these policies.

As the trade-offs between growth and fiscal deficit reduction become more challenging, the government faces the risk of lower-than-expected revenue in the coming years.

This suggests the importance of maintaining tight expenditure controls, even in areas like capital spending, to keep deficits in check, Zook said.

Sustained deficit reduction, adherence to fiscal targets, and continued transparency would further strengthen India's fiscal credibility, which Fitch affirmed when it maintained the 'BBB-' rating with a Stable outlook in August 2024.

However, fiscal metrics remain weak compared to global peers, with general government deficits, debt, and debt service burdens significantly higher than the median for similar economies, it added.

The rating agency said that the government has provided greater clarity on its medium-term fiscal strategy, which aims to reduce central government debt to 50 per cent of GDP (ą 1 per cent) by FY31, about 7 per cent lower than FY25.

Achieving this goal will require keeping fiscal deficits at or below the 4.4 per cent of GDP target for FY26, a task heavily dependent on nominal GDP growth.

On a general government basis, which includes the states, this would imply a deficit of around 7 per cent of GDP and a debt-to-GDP ratio in the low 70 per cent range by FY31.

On Saturday, global credit rating agency Moody's ruled out an immediate upgrade of India's sovereign rating, despite the government's efforts to manage its finances prudently.

To secure a rating upgrade, significant improvements in both the debt burden and debt affordability are necessary, the agency stated.