MUMBAI (Reuters) - Fitch returned India's sovereign ratings outlook to "stable" from "negative" a year after its initial downgrade, citing government measures to contain the budget deficit and the progress made in improving investment and economic growth.
The unexpected upgrade will be a welcome relief to the government, coming during a period when the rupee had slumped to a record low, and endorse months of efforts to contain the fiscal deficit and woo foreign investors.
Government officials had lobbied Fitch after its downgrade to "negative" almost exactly a year ago had roiled Indian markets. Standard & Poor's, the other credit agency that had cut the country's outlook to "negative", has not changed its stance.
"The authorities were successful in containing the upward pressure on the central government budget deficit in the face of a weaker-than-expected economy," Fitch Ratings said in a statement on Wednesday.
"The authorities have also begun to address structural factors that have weakened the investment climate and growth prospects," Fitch added, pointing to efforts to end regulatory uncertainty and delays in government approvals of investment projects that were holding back the economy.
In upgrading India's outlook, Fitch appeared more optimistic about the reform process than many analysts, who worry about the implementation of reform measures and the government's resolve to cut its fiscal deficit.
India has unveiled a series of measures since September, including opening up the aviation and retail sectors to foreign investors in spite of strong political opposition.
Finance Minister P. Chidambaram has also vowed to contain the country's fiscal deficit by cutting spending and raising revenue, though analysts fear increased government spending on populist welfare programmes ahead of elections due by May 2014.
"Today's outlook upgrade will give some medium-term respite and is largely a factor of government's reform measures for putting the fiscal house in order," said Shakti Satapathy, a fixed income analyst in Mumbai.
"However, the consistency in introducing more reforms would count in the coming days, which looks a tad difficult given the election year ahead."
RUPEE RECOVERS
The benchmark 10-year bond yield fell 4 basis points to 7.28 percent after the upgrade announcement, while the rupee also extended gains to close at 57.79/80 after falling to a record low of 58.98 on Tuesday.
Fitch said it expects the government to meet its fiscal 2014 budget deficit target of 4.8 percent of gross domestic product and to gradually reduce its "high" level of debt.
The credit agency said inflation has shown "pronounced" signs of easing while adding it expects the economy to recover to 5.7 percent in fiscal 2014 and 6.5 percent in fiscal 2015.
Despite concerns about India's current account deficit, Fitch added India's external position is a "relative ratings strength", with moderate debt levels and foreign reserves that could cushion adverse global shocks.
Still, Fitch warned of challenges ahead, noting a recovery would remain slow until a healthier investment climate is created, while warning the recent drop in the rupee would complicate policy management by the Reserve Bank of India, limiting the scope for further rate cuts.
Structural budget deficits and high public debt would also constrain India's ratings, Fitch said.
(Reporting by Rafael Nam and Swati Bhat; Additional reporting by Subhadip Sircar; Editing by Sanjeev Miglani)
