Dashing the government's hope of improved credit rating, S&P today retained India's rating at 'BBB-' with a stable outlook and ruled out any upgrade in two years, citing weak public finances.
"The stable outlook balances India's sound external position and inclusive policymaking tradition against the vulnerabilities stemming from its low per capita income and weak public finances," S&P Global Ratings said in a statement.
"The outlook indicates that we do not expect to change our rating on India this year or next, based on our current set of forecasts," it said.
'BBB-' indicates lowest investment grade rating.
S&P said the upward pressure on the credit ratings could emerge if the government reforms markedly improve India's fiscal performance and pushes down the level of net general government debt below 60 per cent of the GDP.
Currently, government debt amounts to about 69 per cent of the GDP.
S&P said improvements in policymaking continue to strengthen and flagged wide fiscal deficits, a heavy debt burden, and low per capita income as concerns.
Downward pressure on the ratings could re-emerge if growth disappoints as a result of stalling reforms or if interest rate-setting monetary policy committee does not achieve inflation targets.
A higher-than-expected deterioration in the nation's external liquidity position could also put downward pressure on ratings, S&P added.
The rating agency expects India's economy to grow 7.9 per cent in 2016 with current account deficit at 1.4 per cent of the gross domestic product. It also expects the RBI to meet its inflation target of 5 per cent by March 2017.
S&P had last in September 2014 upgraded India's rating to stable from negative.
The ratings on India reflect the country's sound external
profile and improved monetary credibility, S&P said, adding the country's strong democratic institutions and a free press promote policy stability and predictability.
Lauding government efforts to build consensus to pass the long pending GST Bill, the ratings agency said it would bring in comprehensive tax reforms through the likely introduction in the first half of 2017.
Other measures include strengthening the business climate, boosting labour market flexibility and reforming the energy sector, it said.
"We believe these measures, supported by India's well-entrenched democracy, will promote greater economic flexibility and help redress public finances over time," S&P said.
The ratings agency further said that India's external position remains a credit strength and it has a floating exchange rate and limited reliance on external savings to fund the growth.
Besides, the authorities also maintain contingent financing facilities of USD 68 billion through bilateral swaps and contingency reserve arrangements, it added.
On India's rating constraint, S&P said the issue is its low GDP per capita at USD 1,700 in 2016.
However, India's growth outperforms its peers and is picking up modestly, it added.
The US-based rating agency expects India's GDP to grow 7.9 per cent in 2016 and 8 per cent on average over 2016-2018.
"We believe domestic supply-side factors will increasingly bind economic performance and the government has little ability to undertake countercyclical fiscal policy given its current debt burden," it said.
This debt load and India's overall weak public finances are additional rating constraints, it said.
India has a long history of high general government fiscal deficits (averaging 8.8 per cent of GDP over the past 20 years and 7 per cent in the past five years).
The deficits have not closed India's sizable shortfalls in basic services and infrastructure, S&P said, adding the country's fiscal challenges reflect both revenue under-performance and constraints on expenditure.
It said India's high fiscal deficits have led to the accumulation of sizeable general government borrowings (about 69 per cent of GDP, net of liquid assets).
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A high proportion of India's resident banking sector's balance sheet is exposed to the government sector via loans, government securities, or other claims on the government, S&P said, adding this implies there may be limited capacity for banks to lend more to the government without further crowding out private-sector borrowing.
India's government borrowings are mostly denominated in rupees, which mitigates the risks, it added.
With regard to banking sector, it said the private sector banks have better profitability, higher internal capital generation and capitalisation with lower-stressed assets than government-owned banks.
"We estimate public-sector banks need capital infusion of about USD 45 billion (2 per cent of GDP) by 2019, given their weaker profitability, to meet Basel III capital norms," the rating agency said.
The government has committed USD 11 billion (0.5 per cent of GDP) to support public-sector banks.
The government may have to increase the allocation if the banks are not able to secure capital from alternative sources, such as equity markets, additional tier-1 bonds, and insurance companies, S&P added.
"Combining our view of India's government-related entities and its financial system, we view the country's contingent fiscal risks as limited," the agency said.
The RBI has made progress in lowering CPI inflation following the introduction in February 2015 of its medium-term inflation target band (with 4 per cent CPI inflation plus/minus 2 per cent as the principal nominal anchor for monetary policy).
"We expect the RBI to achieve the inflation target of 5 per cent by March 2017 as it advances along a glide path to the medium-term inflation target," it added.
These measures by the central bank will support its ability to sustain economic growth while attenuating economic or financial shocks, the rating agency said.
