Interview: Fitch sees India doing all it can to cut fiscal deficit to 4.5% by FY26

Jeremy Zook, a director at Fitch Ratings and the primary rating analyst for India.

The Indian government will try its best to meet the challenging fiscal deficit target of 4.5 percent of the GDP by 2025-26, according to Jeremy Zook, a director at Fitch Ratings and the primary rating analyst for India.

“…we do note that the government has achieved its fiscal targets over the past couple of years. So, there does seem to be a growing importance placed on meeting fiscal targets,” Zook told Moneycontrol in an interview. “That's a sign the government will likely make the maximum effort to reach the 4.5 percent target despite the challenges.”

While India’s revenue collections keep rising — Goods and Services Tax collections hit an all-time high of Rs 1.87 lakh crore in April — Zook thinks they will soon plateau. As such, fiscal consolidation will have to be driven by expenditure cuts. With subsidies already coming off somewhat, this may mean a cut in the capex.

“It’s not what we are suggesting. But it's sort of an escape valve in the absence of additional measures to address these issues,” Zook said.

India’s capex drive is quite positive for medium-term growth. “That's why we think it will be a challenging policy trade-off for the government to make given the importance of closing the infrastructure gap and helping attract FDI (foreign direct investment) flows,” he added.

Zook’s comments come in the wake of Fitch affirming its BBB- rating on India with a "stable" outlook. Later in August, India will complete 17 years as a BBB- rated country by Fitch. When asked if India, despite its high rate of growth, is resigned to staying at the lowest investment-grade rating on account of its weak public finances, Zook said it has been “a remarkably stable credit story, both to the downside and to the upside”. Edited excerpts:

When Fitch affirmed its rating on India on May 8, you said the external finances are resilient. Is the Indian economy in a materially stronger position now than it was seven-eight months ago when its foreign exchange reserves were depleting rapidly?

India’s external finances are certainly in much better shape than they were seven-eight months ago. But we were never overly concerned about the external position. We saw the current account deficit widen quite a bit and foreign exchange reserves drop sharply. But our base case was it was going to be a temporary phenomenon – the current account deficit would moderate and the RBI would rebuild the reserves. And we're seeing that happen. It's actually happening a lot faster than what we anticipated. So that is certainly a positive for the economy and macro stability as well as a supporting factor for the rating.

Your GDP growth forecast of 6 percent for 2023-24 is half a percentage point lower than the Indian government and the RBI’s. Is their optimism justifiable or do the Indian authorities run the risk of underestimating the possible downside to growth?

First of all, in most countries that we cover, our forecasts rarely line up with the government’s official forecasts. If you look at the high-frequency indicators, they're holding up quite well so far. That shows maybe there's some greater resilience in economic activity than what we have in our forecasts. That being said, we think it is still a challenging economic environment. While India is still somewhat more insulated than other countries, especially in the Asia-Pacific region, it's not immune from the impact of a slowdown in global growth. Slowing global growth is feeding through the goods exports and we're seeing that weigh on the economy a bit.

The policy rate has been increased quite substantially over the past year. In our view, that will likely constrain investment growth to a degree, although we expect that to still be somewhat resilient. Then there are base effects and pent-up demand during the pandemic. Our view is that consumption will continue to moderate as some of that pent-up demand begins to fade.

I suppose what you're seeing is perhaps a little more resilience in the informal sector. That's something that we'll keep an eye on. Overall, I think the risks around our 6 percent forecast are certainly becoming a bit more balanced.

What gives Fitch confidence about private sector capex in India despite credit growth slowing down in recent months?

We are taking a position on the medium-term growth outlook. In the near term, certainly, there are still headwinds to investment due to the elevated global uncertainty and high interest rates. Risk aversion is keeping some corporates on the sidelines for a bit longer. Interest rates have been raised quite significantly and that has increased the cost of borrowing and we are seeing that feed through a bit in terms of credit growth stabilising recently.

But over the medium term, if we take a more structural view and look back at the way things were pre-pandemic in 2019 when bank balance sheets were in quite a poor shape and corporate leverage ratios, while on the decline, were higher, India is now in a situation where bank and corporate balance sheets look much healthier. That, we think, is putting India in a good position structurally to drive a new private investment cycle. But it may take beyond this year for that to really kick in.

You have maintained for some time now that greater clarity is required on how the fiscal deficit target of 4.5 percent of GDP will be achieved by 2025-26. Do you think the government is just hopeful that its revenues will keep increasing enough to meet the target without large-scale expenditure cuts?

Revenue collection has certainly continued to exceed expectations. But our view is that it will start to plateau relatively soon, which will constrain the government’s ability, in the absence of additional revenue reforms, to really drive fiscal consolidation from the revenue side. So, yes, reducing the fiscal deficit to 4.5 percent remains a challenging target and will probably require a lot of trade-offs and considerations in terms of expenditures.

The spending on subsidies has come down quite significantly in the past couple of years and is closer to pre-pandemic levels. So, it's difficult to see that being trimmed much more. Capex is at a historic high, so there is some space to cut back there. But that would involve greater trade-offs and considerations for the government when it comes to balancing growth-oriented fiscal policy and fiscal consolidation. The capex drive that the government has undertaken is quite important for the medium-term outlook.

That being said, we do note that the government has achieved its fiscal targets over the past couple of years. So, there does seem to be a growing importance placed on meeting fiscal targets. That's a sign the government will likely make the maximum effort to reach the 4.5 percent target despite the challenges.

Does that mean the Indian government may end up cutting its capex by 2025-26 to meet the fiscal deficit target?

It’s not what we are suggesting. But it's sort of an escape valve in the absence of additional measures to address these issues. We certainly think the capex drive is quite positive for medium-term growth and that's why we think it will be a challenging policy trade-off for the government to make given the importance of closing the infrastructure gap and helping attract FDI flows.

With several state elections due in 2023 before the national election in 2024, how does Fitch view the fiscal cost of pre-poll promises or freebies?

It’s always a risk before elections, and not just in the case of India that governments ramp up spending to support their outlook going into an election.

If you look at the Union Budget, the government has outwardly tried to avoid some of the more populist measures – the subsidy bill, as I mentioned, has been trimmed. That is a positive signal that the government is trying to avoid populist spending measures in the run-up to the election. It seems to us, given the BJP government's quite strong political position despite the result of the Karnataka elections, that they can follow through with those plans and continue to trim spending and consolidate despite it being an election year. Yes, there are some risks, but we're not overly concerned about them – at least in this election year. We think the government is committed to reaching the 5.9 percent fiscal deficit target for 2023-24 and we do see that as relatively achievable.

At the state level, the aggregate deficit has come down quite sharply over the past couple of years back to essentially where they were prior to the pandemic. So, state finances look to be in relatively decent shape, with spending being relatively constrained. On an aggregate level, state finances are not necessarily a large drag on the fiscal outlook in our view.

India, for all its high rate of growth, is hampered by public debt, with key metrics significantly worse than those of BBB category peers. Is India in a position where it can’t really improve upon its BBB- rating?

India’s rating over the past almost two decades, 17 years, has been BBB-. It's been a remarkably stable credit story, both to the downside and to the upside.

Our ratings are an absolute as well as a relative measure. India's public finances are the key weakness in the credit profile in our view. The high debt ratio and the interest-to-revenue ratio are key structural concerns. We also mention in our report what could drive the rating upwards – a more consistent and gradual decline in the public debt ratio would be a positive. That can be driven both by fiscal consolidation but also by GDP growth. A fiscal consolidation plan or reforms to boost medium-term growth further would both have a positive impact on debt levels and dynamics. That being said, we assume 10.5 percent nominal growth, which is relatively high. So, the incremental impact of, say, 11.5 percent nominal GDP growth would certainly have a positive impact, but would likely be a bit challenging to achieve.