Fitch affirms India at ' BBB ' : Outlook stable

Fitch Ratings has affirmed India's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB-' with a Stable Outlook.

Key Rating Drivers
India's rating balances a still strong medium-term growth outlook compared with 'BBB' category peers and relative external resilience stemming from solid foreign-reserve buffers against high public debt, a weak financial sector and some lagging structural factors, including governance indicators and GDP per capita.

Our outlook on India's GDP growth is still solid against that of peers, even though growth has decelerated significantly over the past few quarters, due mainly to domestic factors, in particular, a squeeze in credit availability from non-banking financial companies (NBFC) and deterioration in business and consumer confidence. Fitch expects growth to slow to 4.6% in the financial year ending March 2020 (FY20), from 6.8% in FY19, which is still higher than the 'BBB' median of 2.8%. We expect growth to gradually recover to 5.6% in FY21 and 6.5% in FY22 with support from easing monetary and fiscal policy and structural measures that may also support growth over the medium term.

The affirmation of the ratings incorporates our expectation of moderate fiscal slippage relative to the central government's deficit target of 3.3% of GDP in FY20. The government is again facing a trade-off between stimulating the economy and reducing the deficit in the medium term. Some fiscal slippage has occurred in recent years against government targets, even during periods of sustained stronger growth. The FY20 deficit target had already been exceeded by end-October due to a weak revenue intake, and deceleration of nominal quarterly growth suggests further revenue pressure for the rest of the financial year. The government has indicated that its corporate tax rate cut could lower revenue by 0.7% of GDP in FY20 and hopes to finance spending by more aggressive asset divestment, including Air India and Bharat Petroleum Corporation Limited (BBB-/Stable). We believe there is a risk of more significant fiscal loosening in the event of continued weak GDP growth, for example, in the context of lingering problems in the NBFC sector.

The limited fiscal space to counter the deterioration in growth was to some extent already factored into the rating in recent years, as we continued to highlight the risks related to a fragile financial sector and weak fiscal position. Fitch expects a general government debt level of 70.4% of GDP in FY20 ('BBB' median: 41.1%) and a general government deficit of 7.5% of GDP ('BBB' median: 1.8%). We consider it highly unlikely that the government will comply with the general government debt ceiling of 60% of GDP by March 2025, as stipulated in the Fiscal Responsibility and Budget Management (FRBM) Act.

Fitch expects the Reserve Bank of India (RBI) to cut its policy rate by another 65bp in 2020, after a cumulative 135bp easing since February 2019. The uptick in inflation to 5.5% yoy in November appears to reflect a temporary spike in food inflation, while pressure on core inflation, which remained stable at 3.5%, seems limited in the current environment. The RBI has built a solid monetary policy record since the inception of the Monetary Policy Committee in October 2016, with headline inflation remaining within the medium-term inflation target range of 4% +/- 2%.

The government is likely to remain focused on reforms during the second term of Prime Minister Modi. It has announced some structural measures over recent months to counter the growth slowdown, including efforts to reduce red tape and boost foreign direct investment. It also plans to consolidate the state-owned banks. The positive impact of these reforms on growth is likely to materialize in the medium term, rather than the near term, and will depend on the details and implementation. The cut in the base corporate tax rate to 22%, from 30%, has already been implemented for companies that do not seek exemptions and the rate for some new manufacturing companies has been cut to 15%, from 25%. The effective corporate tax rate will drop by nearly 10pp, to 25.2%, including surcharges and ceases (levies to raise funds for specific purposes).

Support for NBFCs has so far mainly been routed through public-sector banks following the authorities' encouragement to step up lending to these institutions. It was also provided through an Rs1 trillion (0.5% of GDP) government guarantee to public-sector banks for purchasing highly-rated pooled assets from NBFCs. The measures have not fully arrested liquidity pressure, however, even though funding costs seem to have come off their peak. A shake-out and return of confidence in the sector will take time and may involve the failure of some weak NBFCs. Dewan Housing Finance, reportedly with liabilities to the banking sector of around INR1 trillion, is the first NBFC that the RBI has allowed to start the bankruptcy process under the Insolvency and Bankruptcy Code.

Indian banks generally have thin buffers to deal with continued systemic stress in the NBFC sector, to which their exposure reached 7.4% in FY19. We estimate that banks are already USD7 billion short of the capital required to meet a 10% weighted-average common equity Tier 1 ratio by FY21 - the level that we believe would give the banks an adequate buffer above regulatory minimums. The banking sector's non-performing loan ratio fell to 9.3% in FY19, from 11.6% in FY18, but non-performing loans could build up again in the current weak economic environment.

India has been less affected so far by global trade tensions than many of its peers - given the comparatively closed nature of its economy, which is not part of the Asian supply chain, and comparatively lower export commodity dependence. The government has raised trade tariffs on a number of products to curb imports. India runs a modest current account deficit (1.9% of GDP in FY20), which is only partly financed by net foreign direct investment and is dependent on net oil imports but has relatively strong foreign-exchange buffers. Foreign-currency reserves equal 7.7 months of current external payments ('BBB' peer median: 5.9 months), while gross and net external debt levels also compare well with those of peers.

The Indian economy is less developed on a number of structural metrics than many of its peers. Governance remains weak, as illustrated by a low score for the World Bank governance indicator (49th percentile versus the 'BBB' median of 59th percentile). India's ranking on the United Nations Human Development Index (32nd percentile versus the 'BBB' median of 67th percentile) also indicates relatively low basic human development. Average per capita GDP also remains low, at USD2,102, compared with the 'BBB' range median of USD12,152.

Sovereign Rating Model (SRM) and Qualitative Overlay (QO)

Fitch's proprietary SRM assigns India a score equivalent to a rating of 'BBB-' on the Long-Term Foreign-Currency IDR scale. Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM

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