India’s ratings may be lowered on high fiscal deficit, says S&P

India’s ratings may be lowered on high fiscal deficit, says S&P
The Financial Express, July 9, 2009, Page 13

fe Bureau, Mumbai

Standard & Poor’s Ratings Services has maintained that India’s high fiscal deficits are not sustainable in the medium term and if fiscal consolidation is delayed, there is a risk that the sovereign credit ratings on India (BBB-/Negative/A-3) may be lowered.

Although the Central government Budget deficit of 6.8% of GDP for fiscal 2009-2010 (excluding below-the-line items such as oil and fertiliser bonds) was high at almost double the 2.7% recorded in fiscal 2007-2008, including state government deficits and off-balance-sheet items such as oil and fertiliser bonds, the deficit is estimated to reach about 12% of GDP in fiscal 2009-2010, said Standard & Poor’s.

“We continue to believe that such high levels of government deficits are unsustainable in the medium term, although we were not surprised by the number itself. If India achieves fiscal consolidation in the next two to three years, the sovereign ratings on India could be maintained at ‘BBB-’ and the outlook revised to stable,’’ said the rating agency.

The rating agency has revised the outlook on India to negative on February 24, on expectations of increasing fiscal deficits.

According to the rating agency there was no significant information on the road map for fiscal consolidation or details on the divestment plan for state-owned companies in the Budget speech.

In addition, there were no major tax changes but minor adjustments in the run-up to the planned introduction of the goods and service tax nationally in April 2010.

“We await the 13th Finance Commission report, which must be submitted to the finance minister by the end of October 2009, to garner a broader picture on the fiscal consolidation in the medium term. The contents of the new Fiscal Responsibility and Budget Management Act (FRBM-II) are expected to guide and safeguard fiscal consolidation at central and state government levels. We believe a separate announcement on the divestment plan or other plans on fiscal consolidation is possible,’’ noted the rating agency.

The hefty fiscal deficits and debts outstanding (general government gross debt estimated at 85% of GDP at the end of March 2009) are two of the most significant negative factors on the sovereign credit ratings on India. The other important rating factors for India include its (1) medium term growth prospects; (2) inflation rate and interest rates; (3) progress in structural reforms; and (4) net inflow of funds.

For example, if the pace of recovery of the Indian economy and the medium-term growth prospects are strong, the government will be able to consolidate its fiscal position faster through higher revenue and lower expenditure growth. Progress in structural reforms such as setting automatic adjustment mechanisms for the prices of domestic fuel, fertiliser, and food would also be positive.

In addition, measures increasing the efficiency of the public sector and reducing red tape, as well as facilitating infrastructure investments would be beneficial. On the other hand, higher inflation and interest rates could increase the cost of borrowing and affect the size of fiscal deficits or slow fiscal consolidation. A material deterioration in India’s strong external position—considered unlikely at this stage—could also put pressure on the ratings.