Why India needn't fret over its credit rating

The Budget 2023 struck a fine balance between the need to aid economic recovery while ensuring fiscal consolidation, something which was music to the ears of fiscal hawks and bond traders.

Still, there has been some cautious commentary from global credit rating agencies, specifically in the context of the government's ambitious plan to lower the budget deficit to below 4.5 percent of the gross domestic product (GDP) by FY26.

All the three major rating agencies have the lowest investment grade rating on India with a stable outlook.

Fiscal marksmanship crucial

The government’s commitment to stick to the earlier fiscal consolidation plan had cheered the bond markets on budget day. The credit rating also hinges on this but rating agencies are more circumspect.

India’s stretched fiscal dynamics won’t see much change through FY26, S&P Global Ratings said on February 14.

Still, the Budget 2023 “maintains well-established trends including slow consolidation, and a strong emphasis on capex,” S&P said in a presentation.

Fitch Ratings said in a post-budget note that the slow fiscal consolidation process in the wake of the Covid-19 pandemic could leave the public finances exposed in the event of further major economic shocks.

To be sure, Fitch expects the deficit-reduction plans to stabilise general government debt-to-GDP levels over the medium term, with the budget’s forecasts broadly consistent with its assumptions, thus not significantly changing the view of the sovereign credit profile.

Still, it will be challenging for the government to achieve its 4.5 percent of GDP deficit target by FY26, which would require accelerated fiscal consolidation in FY25-FY26.

In the budget, Finance Minister Nirmala Sitharaman retained this fiscal year’s fiscal deficit projection at 6.4 percent of GDP and said the government would lower the deficit to 5.9 percent in the next financial year.

Going to 4.5 percent of GDP or below by FY26 would mean a 140 basis points reduction in the deficit over two years.

Growth optimism, realistic projections

Despite the note of caution on the fiscal targets, there is good news for India credit rating.

India’s strong medium-term growth prospects are an important support to its sovereign rating, offsetting public finance weakness, rating agencies contend.

The budget assumptions as well as bright growth prospects support the credibility of the fiscal profile.

S&P said that the budget is modestly supportive of growth dynamics, especially as investment will boost long-term productivity.

Fitch believes the budget’s nominal economic growth and revenue assumptions are credible, although risks remain tilted to the downside in light of the uncertain global outlook.

The government’s real GDP growth assumption of 6.5 percent for the fiscal year ending March 2024 is higher than Fitch’s forecast of 6.2 percent, but the budget figure for nominal growth, at 10.5 percent, is similar to Fitch’s.

Fitch forecasts India’s government debt-to-GDP ratio to stabilise at around 82 percent over the next five years, on the back of gradual-but-sustained deficit reduction and robust nominal GDP growth of around 10.5 percent.

Fast capex-led economic growth will be key to the stabilisation of the debt ratio in the absence of swifter deficit reduction, the rating agency said.