Rating assessment of India focused on medium-term debt trajectory: Fitch

"We view the persistent level of core inflation and energy price developments, along with global price pressures, as carrying upside risk for our inflation outlook," said Zook,.

Fitch Ratings' Director, Asia-Pacific Sovereigns, Jeremy Zook tells Indivjal Dhasmana that the agency's move to retain India's ratings at the lowest investment grade and outlook at negative is based on its medium-term debt trajectory and the potential of government policies to reduce it. Edited excerpts:

Don't you think Fitch is an outlier since it still has a 'negative' outlook on India's ratings against 'stable' by S&P and Moody's?

Our rating action commentary reflects Fitch Ratings’ credit views; we do not comment on the ratings of other agencies.

India's high debt and huge fiscal deficit are due to exceptional conditions emanating from Covid-19 waves. Don't you think this warrants an upgrade of the outlook?

It is true that we have seen a rise in deficits and debt globally as a result of the Coronavirus (Covid-19) pandemic. Our rating actions take into account peer medians, as well as individual sovereign’s historical track records with fiscal consolidation. We would note that India entered the pandemic from a position of relative fiscal weakness, and with the highest debt/GDP ratio of any ‘BBB’ emerging market sovereign, had limited fiscal space from a ratings perspective. Our rating assessment for India is focused on the medium-term debt trajectory and prospects of policies to put this ratio on a downward trend.

You said adequate recapitalisation can mitigate the risk aversion currently seen among banks. How much is the amount required for this purpose in the current financial year and the next one?

Under our new base case scenario we do not expect the banking system to require fresh equity capital to keep the system's common equity tier 1 (CET1) ratio above the regulatory minimum of 8 per cent until FY25. Under the stress case scenario, fresh capital of $27 billion would be required. Our base case factors in a gradual reduction in the severity of economic disruption associated with the pandemic, and fiscal measures to drive growth ahead of the 2024 General Election. The stress scenario factors in such an outcome, which would dent economic activity and result in higher pressure on asset quality. We expect system credit growth to average 2.7 per cent during FY22- FY25 under the stress case, compared with 6.7 per cent under our base case.

Why do you see implementation risks associated with various reform measures announced by India such as production linked investment schemes, labour reforms, creation of bad bank and infrastructure programmes?

Reform implementation poses a challenge for many sovereigns, as we have seen in India’s case with the agricultural reforms. However, we view reform prospects positively in India, particularly around the PLI scheme and labour reforms.

Your assessment said mobility indicators have returned to pre-pandemic levels and high-frequency indicators point to strength in the manufacturing sector. Does it give any rationale to the negative outlook?

Our rating is highly dependent on the medium-term outlook. While we note the very strong cyclical recovery in the economy, we believe there is still uncertainty over medium-term prospects, though we do note these uncertainties are narrowing.

You pegged economic growth at 8.7 per cent  for the current financial year and 10 per cent for the next one. Most analysts have pegged higher economic growth for the current financial year than the next one. Why do you think otherwise?

We see a strong recovery underway after the second wave of the Covid-19 pandemic. Solid sequential momentum through FY23 as a result of the sustained vaccination drive and recovery in consumption underpins our current growth outlook. We do note that there is upside to our FY22 growth forecast, which would lead to lower growth next year as a result of base effects.

You said risks are tilted towards higher inflation, given persistent core inflation, increasing energy prices, and rising inflation expectations. Don't you think the recent move by the government to cut petrol and diesel excise duties will ease the inflation rate?

The cut to excise duties can help to contain inflation, however, we view the persistent level of core inflation and energy price developments, along with global price pressures, as carrying upside risk for our inflation outlook.