Fiscal deficit may invite rating agencies' ire, Fitch may downgrade: Report

Global rating agencies may view the fiscally expansive budget proposals negatively, a brokerage said

Global rating agencies may view the fiscally expansive budget proposals negatively and there is a risk of one of them downgrading India's sovereign rating, a Japanese brokerage said on Friday.

Fitch Ratings, one of the two having a negative outlook on India's rating, may downgrade the rating to junk, Nomura warned.

In a move widely hailed for its transparency, Finance Minister Nirmala Sitharaman on Monday said the fiscal deficit will come at 9.5 per cent on the back of high spending during the pandemic, and will narrow to 6.8 per cent in FY22. It can be noted that the country was on a path to get the gap to 3 per cent in the medium term earlier.

We believe rating agencies may view the budget as slightly more negative, given their focus on medium-term fiscal finances. Of the two rating agencies with a negative outlook for India, we believe the budget may have increased the probability of a downgrade from Fitch, the note from Nomura said.

The positives in the budget from the rating agencies' perspective include creation of a bad bank to house dud debt, increased infrastructure spending, realistic assumptions and greater fiscal transparency, while there are a few negatives as well like weak medium-term fiscal commitment and larger size of the government, it said.

In a note released hours after the Nomura report, Fitch indeed flagged risks over the fiscal roadmap from the medium term perspective.

Deficit targets presented in India's central government budget on February 1 are higher, and medium-term consolidation more gradual, than we expected," said Jeremy Zook, Director in Fitch Ratings' Asia-Pacific Sovereigns team.

Nomura said the decision to spend more is a volte-face from an earlier strategy on conservatism and reflects its view of higher multiplier effects during the unlock phase and higher growth as a pre-condition for debt sustainability.

The move has been welcomed by a host of analysts as the answer to help the economic recovery. It can be noted that the Economic Survey had raised question marks over the credibility of rating agencies in the run up to the budget.

At present, India's rating is one notch above junk and any downgrade can potentially increase the cost of debt for the government.

While higher fiscal deficits can lead to sovereign downgrades, the alternative of stunting the India story by a tight fiscal policy is surely worse, analysts at Bofa Securities, an American brokerage, wrote on Tuesday.

In a note, analysts at Credit Suisse explained that the deficits in FY21 and FY22 were driven by inclusion of earlier "off-budget" items and very low revenue assumptions at only 5 per cent in gross taxes across FY20-22, and higher expenditure.

Nomura said the Reserve Bank, which can raise concerns from an inflationary standpoint in tandem with the rating agencies, is likely to view the budget as a medium-term positive and maintain a dovish hold at the forthcoming policy review later this week.