S&P cautions India against fiscal vulnerabilities to credit profile

Says 'less than rock solid' public finances remain a concern for India's sovereign rating profile

Rating agency Standard & Poor’s (S&P) on Monday said structural fiscal weakness can be a drag on India’s sovereign credit profile. Like the other two rating agencies — Moody’s Investors Service and Fitch Ratings — S&P, too, has India at the lowest investment grade.

However, unlike Moody’s action to upgrade outlook on India’s rating last week, S&P did not take any action on outlook, which remained at ‘stable’.

In a report titled ‘India’s Fiscal Roadblocks Could Stall Infrastructure Progress,’ S&P warned that any financial or commodity shock could unwind its recent fiscal improvements.

“The Centre’s willingness to cut spending to rein in the Budget deficit indicates the high priority of fiscal prudence on its agenda... From an institutional and governance point of view, this supports the (existing) sovereign credit rating on India. However, structural fiscal weaknesses continue to be vulnerabilities of Indian sovereign creditworthiness,” said S&P credit analyst Kim Eng Tan. Although they clarified that only a Rating Committee can determine a credit rating action and this analysis should not be interpreted as rating or outlook move, the statement, nonetheless, is harsher than from Moody’s, which had upgraded outlook on India’s rating to ‘positive’ from ‘stable’ last week.

Moody’s had also said it affirmed the lowest investment rating for India, keeping in mind India’s weaker performance on the fiscal and other fronts. However, it had also added that the government’s policies were beginning to address these factors, but the extent of likely improvements was still unclear. The rating agency had also said it would watch developments in 12-18 months to see whether the rating itself could be upgraded or not.

According to S&P, the Centre’s efforts to go for fiscal consolidation justifies India’s lowest investment rating, cautioning that its credit profile could face a downside risk from structural fiscal weakness. Fitch, on the other hand, had retained outlook on India’s lowest investment rating to ‘stable’ last week.

What are these structural fiscal vulnerabilities? The report noted that India’s Budget deficit has fallen in recent years, relative to GDP. The Centre’s fiscal deficit is projected to come down to 4.1 per cent in 2014-15 from 4.5 per cent in the previous year. This is an improvement in the fiscal consolidation exercise, which targeted the deficit to be 4.2 per cent in 2014-15 and 4.8 per cent in 2013-14.

“However, the latest-year deficit reduction didn’t come easy. Disappointing tax collections, especially services tax collection, dragged estimated total revenue for the fiscal year ended March 2015 by 6.3 per cent below the central government’s initial Budget projection,” it added.

The government had to cut spending by a similar proportion to prevent the Budget shortfall from widening. Since the subsidy Bill came in above expectations, the government made significant cuts to capital investments to bring spending down.

The rating agency said without further fiscal reforms, the Union government might find it difficult to sustain the increase in public investment spending.

In the mid-year analysis of the economy last year, chief economic adviser Arvind Subramanian had pressed for enhanced public investments since corporate balance sheets are highly leveraged.

Tan further said, “Although India’s budgetary performances have strengthened in recent years, its hard-won fiscal improvements could yet unwind because of a financial or commodity shock.”

The analyst said the subsidy spending is one of the key sources of weakness, despite fuel-subsidy reforms in 2014.

“Another constraint is the heavy government debt,” said Tan.

The large interest payments and subsidy spending in Budgetary expenditure are signs of fiscal risks because they leave little for the Centre to spend at its discretion, after necessary social services expenditure.

Further constraining public infrastructure financing is the government’s relatively small share of GDP that it collects as revenue.

“This is why public investment in India has been persistently lower than that of some other developing countries. The central government appears intent to change this. It has bumped up capital spending for the fiscal year to March 2016 by more than 25 per cent, which is significantly higher than the average 5.4 per cent growth since fiscal 2011-2012,” the rating agency said.

It further said an unexpectedly sharp increase in interest rates could still raise India’s budgetary interest payments.

“Similarly, if food and fertiliser prices are markedly different from assumed levels, the subsidy bill could be larger than expected. In either scenario, particularly if divestment targets are also not met, the government could find it necessary to cut capital spending again to meet its deficit target,” said S&P.