India sovereign credit risk from rupee decline is limited: Fitch Ratings

Fitch Ratings on Monday said that its outlook on the recent sell-off in the rupee illustrates that India's sensitivity to shifts in the market sentiments towards emerging markets, with further pressure as global monetary tightening progresses.

However, the impact of currency weakness on India's sovereign credit profile is likely to be limited by relatively strong external finances, especially the low level of external debt.

"Currency depreciation could nevertheless add to existing pressures in the corporate and banking sectors," said Fitch Ratings in its statement.

It added that the rupee has been among the emerging-market currencies affected by pressures from global monetary tightening and, more recently, contagion from the Turkey crisis. It has depreciated by around 9% against the US dollar since the start of 2018, making it the worst-performing major currency in Asia (see chart).

Adding to this, Fitch added that India's vulnerability to currency risk and capital outflows is unlikely to translate into significant pressure on the sovereign credit profile or pose external financing risks.

"We expect the full-year current account deficit to remain below 3.0% of GDP in the fiscal year ending March 2019. Foreign-exchange reserves have declined by USD24 billion since mid-April 2018, but still cover 7.2 months of current account payments, compared with the 'BBB' median of 6.6, providing a buffer should the Reserve Bank of India (RBI) feel it necessary to intervene on a larger scale," it added.

India also has relatively low foreign-currency debt. Only around 7% of government debt is denominated in foreign currency (BBB median: 38%), while total foreign-currency external debt, including the private sector, is equivalent to just 13% of GDP, which is one of the lowest among major emerging markets.

Meanwhile, the risk of currency pressures triggering a sudden spike in domestic borrowing costs is mitigated by the RBI's relatively narrow focus on its inflation objective, as opposed to countering external pressures. This is in contrast to the approach in Indonesia, for example, where the central bank has responded to currency pressures with aggressive interest rate increases. External pressures may be enough to prompt another 25bp hike this year, but dramatic moves by the RBI to defend the currency appear unlikely in Fitch's view.

The banking sector has relatively low direct foreign-currency exposure, with foreign-currency loans accounting for just 10.9% of total loans in March 2018, as per Fitch's estimate, compared with 12.1% a year earlier. However, domestic-currency lending to corporates with unhedged foreign-currency borrowings could face increased repayment risk. Moreover, Indian banks are already struggling with asset-quality problems and have thin loss-absorption buffers to cope with further stress.