India's institutional strengths and high international reserves support our investment-grade rating on India.
However, we note a marked slowdown in real growth, which complicates the government's debt dynamics and ability to implement reforms.
We are affirming our 'BBB-/A-3' sovereign credit rating on India.
The outlook remains negative, indicating that we may lower the rating to speculative grade next year if the government that takes office after the general election does not appear capable of reversing India's low economic growth.
Rating Action
On 07 November 2013, Standard & Poor's Ratings Services affirmed the 'BBB-' long-term and 'A-3' short-term unsolicited sovereign credit ratings on India. The outlook on the long-term rating remains negative.
Rationale
Our rating affirmation rests on several key strengths of India. These include a robust participatory democracy of more than 1 billion people and a free press; low external debt and ample foreign exchange reserves; and an increasingly credible monetary policy with a largely freely floating exchange rate.
These strengths are counterbalanced by significant weaknesses, which include an onerous burden from its public finance, lack of progress on structural reforms, and shortfalls in basic services typical of a nation with a GDP per capita of US$1,500. Real per capita growth had averaged more than 6% annually for fiscal year 2004-2011 (ended March 31, 2011), and had eased India's fiscal constraints and poverty levels. But growth has slowed steadily since then to half that level, fraying the social contract and putting at risk the declining trend in government debt.
The vibrancy of India's democracy will again come to the fore in general elections, which are due no later than May 2014. Power has alternated between the Congress Party and the BJP Party since 1998. The next government, regardless of its composition, will face several challenges. The 13th Finance Commission has recommended a central government fiscal deficit target of 4.2% of GDP in the fiscal year ended March 31, 2013. Although the current Congress administration tried to close the gap to this target, it did so by having one-off measures such as compressing unspent budget allocations and selling minority stakes of nonfinancial public enterprises to public sector financial enterprises.
Achieving the government's own fiscal deficit target of 4.8% of GDP in fiscal 2014 will depend partly on the government's resolve on the level of election spending and on the evolution of commodity prices. The central government's budget balance, however, tells only part of the Indian fiscal story. Using a broader measure of general government deficits, we project a 7.2% of GDP deficit for fiscal 2014, to which one should add 1-2 percentage points of GDP deficits for the unprofitable portions of the consolidated public sector, including state electricity boards and oil-marketing companies.
The Indian government has sent mixed signals on subsidy policies. On the positive side, the government has decided to deregulate domestic diesel prices and state-owned oil companies are increasing their domestic prices in steps. The government had planned to phase out diesel subsidies (its single most costly subsidy) by year-end. However, global oil prices that are higher than what the government was expecting in its plans and the depreciation of the rupee against the dollar will delay the phasing-out of diesel subsidies. On the negative side, the government has secured parliamentary approval to expand coverage of food subsidies to almost two-thirds of India's households. This act could almost double the size of the government's food subsidy in future budgets to about 1.5% of GDP.
The new government will face difficult tasks to place its fiscal accounts on a firmer footing: phasing out of diesel subsidies, financing the expansion of food subsidies, addressing other subsidies such as those for fertilizer, and introducing the nationwide rollout of a common goods and services tax.
India's repressed financial system has accommodated its high fiscal deficits. Real interest rates on government debt are consistently negative. The Reserve Bank of India's (RBI) newly established consumer price index rose 9.8% year on year in September 2013. Central government debt represents more than a quarter of the assets of the Indian banking system. Although high inflation eases the government's debt as a share of GDP, it distorts relative price signals, depresses real growth, and has negatively affected the lives of the poor. We expect India's net general government debt to GDP (by our own definition) to fall to 70% by the end of the current fiscal year in March 2014, although interest costs will still consume nearly a quarter of revenues. However, we expect the financial sector, under the new leadership in the central bank, to be gradually liberalized and a steady disinflationary environment to emerge.
Finally, India's external position is an element of strength for the rating, although we see some fragilities. As of the end of March 2013, India's foreign currency reserves covered about six months of current account payments. External debt net of liquid assets equaled only 9% of current account receipts (CAR), and the broader measure of net external liabilities to CAR was a bit higher at 53%. These indicators suggest that India does not face the same degree of risks in maintaining the confidence of external creditors as that faced by some other countries at a similar stage of development with more open financial accounts.
We expect current account deficit to narrow slightly to about 3.7% of GDP by March 2014, mainly because of government restrictions on the import of gold and weaker domestic demand; many Indians buy gold for investment. India's current account deficit widened significantly in 2013 to about 5% of GDP, the highest in more than a decade, which had seen deficits more in the range of 1%-2% of GDP. The deterioration of the current account and changing perceptions about global liquidity conditions weakened confidence in the rupee, leading to a 22% fall in its value against the dollar between May and August this year. Outlook The negative outlook indicates that we may lower the rating to speculative grade next year if the government that takes office after the general election does not appear capable of reversing India's low economic growth. Barring an unexpected deterioration of the fiscal or external accounts before the election, we expect to review the rating on India after the next general elections when the new government has announced its policy agenda. If we believe that the agenda can restore some of India's lost growth potential, consolidate its fiscal accounts, and permit the conduct of an effective monetary policy, we may revise the outlook to stable. If, however, we see continued policy drift, we may lower the rating within a year.
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