S&P Affirms India's Sovereign Ratings at 'BBB-/A-3' with Stable Outlook on Gradual Recovery
Moneylife Digital Team 13 July 2021
S&P Global Ratings has affirmed its 'BBB-' long-term and 'A-3' short-term unsolicited foreign and local currency sovereign ratings on India with a stable outlook. The BBB- ratings from S&P denotes the entity to have adequate capacity to meet financial commitments, but more subject to adverse economic conditions. 
In a release, the ratings agency says, "The stable outlook reflects our expectation that India's economy will recover following the resolution of the COVID-19 pandemic, and that the country's strong external settings will act as a buffer against financial strains despite elevated government funding needs over the next 24 months." 
S&P says, the sovereign credit ratings on India reflect the economy's above-average long-term real gross domestic product (GDP) growth, sound external profile and evolving monetary settings. 
"India's democratic institutions promote policy stability and compromise, and also underpin the ratings. These strengths are balanced against vulnerabilities stemming from the country's low per capita income and weak fiscal settings, including consistently elevated general government deficits and indebtedness," it added.
While India's economy continues to outperform peers at a similar level of income on a 10-year weighted average real GDP per capita basis, its performance on this metric has weakened somewhat, the ratings agency says adding, prior to the onset of the COVID-19 pandemic, the Indian economy had already slowed measurably.
It says, "We expect economic activity in India to begin to normalize throughout the remainder of fiscal 2022, resulting in real GDP growth of about 9.5%. A significant proportion of this rebound will be due to the very weak base in the prior fiscal year, when the economy contracted by a record 7.3%." 
India's severe second COVID-19 wave, which appears to have peaked in May 2021, has undermined the healthy recovery momentum observed in the economy from September 2020 through March 2021. 
During that period, high frequency economic indicators, financial sector data, infrastructure capacity utilisation, mobility and good and services tax (GST) receipts all showed strong signs of recovery, exhibiting the economy's potential when pandemic-related restrictions are lifted.
If the second wave of COVID-19 continues to abate, S&P says it expects India's economic buoyancy to return, and that increased mobility and pent-up demand will power a strong recovery in the second half of the current fiscal year. These near-term prospects remain contingent upon the prevention of further severe epidemic waves, which are highly unpredictable, it added. 
According to the ratings agency, the pace of India's ambitious COVID-19 vaccination campaign will be crucial to the mitigation of adverse outcomes from future pandemic waves. 
It says, "The nationwide rollout has picked up pace over the past month, helped by increasing domestic supply. India is among a small group of emerging markets with extensive domestic vaccine manufacturing capabilities. Nevertheless, officials face stout challenges in establishing broad-based coverage for the nation's large population, the majority of which live in rural areas." 
The Indian economy's long-term outperformance highlights its historical resilience, the ratings agency says adding, the country's wide range of structural trends, including healthy demographics and competitive unit labour costs, work in its favour. 
"These strengths have been challenged by the extent of the pandemic, and financial and corporate sector weaknesses. A cyclical investment downturn also predated the pandemic, and a rebound in private sector investment will be a key determinant of the economic recovery's longevity," S&P says. 
On the regulatory front, important steps taken by the Union government that led to some improvement in financial sector practices will be delayed amid the pandemic. While restructuring and moratorium programmes introduced by the Reserve Bank of India (RBI) are helping to alleviate immediate pressure on banks' balance sheets, the rating agency feel, this will also likely delay the realisation of banks' exposure to distressed or insolvent firms. 
According to S&P, the implementation of India's complicated national GST created some disruption as state and Central governments gradually modified details of the tax. However, it says, there are signs that these disruptions are beginning to ease, and it expects progress in India's tax collection regime to support economic growth. 
Notably, GST revenues showed a marked improvement prior to the most recent virus outbreak, it added. 
The Bharatiya Janata Party (BJP)-led coalition government retains a healthy majority in the Lok Sabha, or India's lower house of parliament, supporting its efforts to implement economic reforms. 
The Central government, in fiscal 2021, approved three labour reform bills that should help to liberalise employment practices in the country, especially at small and midsize enterprises (SMEs) with fewer than 300 employees. 
"State elections in 2022 will provide a gauge of the BJP's popularity in the Rajya Sabha, or upper house, following the disruptive second wave of COVID-19," S&P says.
The Indian government introduced a brawny budget for fiscal 2022, with a 137% increase in healthcare expenditure and a 34% boost to capital expenditure, versus what was initially budgeted in the previous year. The Budget follows comprehensive support measures implemented throughout fiscal 2021, although direct fiscal injections were fairly modest under that programme. 
According to S&P, although the government's robust expenditure programme this year should help the economy to heal faster, it will also further strain its weak finances. "This increasingly tenuous balance may challenge India's capacity to maintain sustainable public finances and balanced economic growth, if the recovery is slower than we anticipate," it added.
The Union government's stimulus measures have leaned heavily on guarantees as well as on the banking sector and the RBI to support the economy and the financial sector. Amid the second wave of infections from March 2021 onward, the bulk of support measures has ostensibly been provided by the RBI. 
As before, the ratings agency says, these measures target the hardest-hit individuals, micro, small and medium enterprises (MSMEs), and non-bank financial institutions (NBFIs), and should help to contain immediate stress in the broader financial sector.
"There is a risk that some damage to the real economy from India's deep economic downturn last year, and the more recent virus outbreak, could be enduring. Implementation and acceleration of key reforms could help to address this risk over the next few years," S&P warns.
The Indian government has exhibited an awareness of the necessity of reforms to boost productivity in the long run. In 2019, it announced a package of corporate tax reforms that reduced the domestic corporate income tax rate to 22%, from 30% previously, as long as companies do not employ other incentives or exemptions. 
Companies making fresh investment in manufacturing may get an even lower rate of 15%. The new corporate tax framework also includes preferential tax rates for new manufacturing companies. Other reforms announced in 2020 include the relaxation of limitations on investment into the defence sector, liberalisation of domestic agricultural markets, and easing of restrictions on commercial mining. 
Critically, S&P says, some local governments have made further progress in loosening restrictive labour market policies at the state level. These efforts are likely in coordination with the Central government, which passed three associated labour bills in September 2020. "Should these measures become more permanent, with broadening participation from other states, they could help India's labour market to normalise more quickly following the containment of the pandemic," it added.
The Union government's ability to deliver and execute additional economic reforms, especially those that spur investment and job creation, will be important for India's ability to recover from the economic slowdown, the ratings agency says, adding, existing vulnerabilities, including a relatively weak financial sector, rigid labour markets, and sluggish private investment, could hamper the economic recovery if not meaningfully addressed. 
"Although India's banking sector has ample liquidity, risk appetite is still limited. Credit extension to less creditworthy borrowers in the NBFI space may be weak for some time owing to heightened prudence in banks' lending standards. Government measures aimed at backstopping NBFI debt have helped to alleviate these conditions to some extent. Liquidity risks are more prevalent in some parts of the NBFI sector, especially for firms in the automobile, SME, and microfinance segments," S&P says.
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