Improve public finances, Fitch tells India

By agencies   |   Friday, 20 May 2005, 07:00 Hrs
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NEW DELHI: Terming India's weak public finances as ''a binding constraint on its sovereign ratings'', Fitch today affirmed the country's foreign and local currency ratings at 'BB+.'

The outlook is stable, said the international rating agency.

Fitch Rating pointed out that despite India's external strengths, such as solid external liquidity and a declining external debt burden, its high fiscal deficit prevents the country from achieving an investment-grade rating in the near term.

''In essence, India's weak public finances have become a binding constraint on its sovereign ratings,'' Fitch Senior Director on Sovereigns Team, Shelly Shetty said.

Fitch said future-rating changes would hinge upon the progress made by authorities to improve public finances.

''Swifter deficit reduction would place public debt on a stronger footing and encourage a virtuous cycle of lower interest rates, greater private investment and higher economic growth, all of which will be supportive of a higher sovereign rating,'' said Shetty.

In recent years, India's favorable macro conditions have prevented an escalation in the government debt burden. However, Fitch stressed that it is critical that complacency does not set in with regard to the need to implement fiscal reforms, as debt dynamics remain vulnerable to a sharp and prolonged slowdown in growth and rise in interest rates.

Moreover, the general government debt stock of over 80 percent of Gross Domestic Product (GDP) is significantly higher than the 'BB' median and a further build-up in public debt would undermine the ability of the government to respond to shocks.

Fitch said India's ratings are supported by its strong international liquidity position, a declining external debt burden, its improving growth prospects, and its robust political and private sector institutions.

With a rapid build-up in international reserves that reached $137 billion at the end of 2004-05, Fitch estimated that India has turned into a net external creditor. Moreover, strong export growth has placed external debt ratios on a solid downward trajectory. India's external debt as a percentage of current external receipts (CXR) is estimated to have declined to 97 percent in 2004-05 compared to 114 percent for the 'BB' median.

''However, the country is expected to record current account deficits in the coming years and the financing of these deficits could increasingly become dependent on foreign portfolio inflows, which are traditionally more volatile,'' said Shetty.

The agency noted that that the strong foreign capital flows into India in recent years might partly reflect low global interest rates; as such, it is critical for India to accelerate the reform process and deliver on higher growth to maintain its attractiveness to foreign portfolio investors.

But its poor record of controlling large and persistent fiscal deficits was the main factor holding India's ratings in check.

General government deficits at 9 to 10 percent of GDP are nearly triple the level of the 'BB' median and five times the 'BBB' median.

In addition, interest payments represent nearly one-third of general government revenues, which is very high compared to similarly rated sovereigns.

Despite the fiscal weaknesses, the 2005-06 budget missed the opportunity presented by high growth to consolidate the fiscal accounts faster.

Although the government has reaffirmed its commitment to achieve a zero revenue deficit by 2009, and it has provided incentives to states to achieve the same, much will depend on the implementation of tax-enhancing and expenditure-reducing policies.

Nonetheless, India's near-term growth prospects appear to be fairly robust, a consequence of past reforms and the resultant restructuring by the Indian private sector, Fitch said.

The main drivers of growth will be higher consumption and infrastructure spending, and higher growth in the services and industrial sectors.

''However, we believe that sustaining a 7 percent growth rate and increasing it to 8-10 percent will depend on the ability of the government to implement structural reforms, including fiscal consolidation and further disinvestment, and easing of infrastructure bottlenecks,'' said Shetty.

Fitch expected the new government to continue with reforms albeit at a slow pace due to the constraints imposed by coalition politics.

Progress on controversial issues like labor reform and strategic disinvestment, which are critical to fostering greater market forces and improving overall productivity growth, is unlikely.

However, further liberalization of the foreign direct-investment regime, minority sales in public sector enterprises, financial reforms, and steady trade liberalization could continue, it said.

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