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Fitch Ratings on Tuesday reaffirmed its lowest investment grade (BBB-) sovereign rating for India with negative outlook holding that the country’s rating balances a still-strong medium-term growth outlook and external resilience from solid foreign-reserve buffers, against high public debt, a weak financial sector and some lagging structural issues.  

The rating action by Fitch maintaining the negative outlook will disappoint the government since only last month, Moody’s Investors Service had upgraded India’s sovereign credit rating outlook to stable from negative while keeping its credit rating unchanged at Baa3, citing receding risks posed by the financial sector to the overall economy. S&P Global Ratings in July also reiterated its lowest investment grade rating with stable outlook for India.  

 “The country's rapid economic recovery from the covid-19 pandemic and easing financial sector pressures are narrowing risks to the medium-term growth outlook. However, the negative outlook on the rating reflects lingering uncertainty around the medium-term debt trajectory, particularly given India's limited fiscal headroom relative to rating peers," Fitch said. 

The rating agency warned that India could face a rating downgrade if it fails to put the general government debt/GDP ratio on a downward trajectory, for instance, from insufficient fiscal consolidation. A structurally weaker real GDP growth outlook due to continued financial-sector weakness or lacking reform implementation could further weigh on the debt trajectory, it added.  

India’s rating could see an upgrade, Fitch said, if implementation of a credible medium-term fiscal strategy to bring post-pandemic general government debt veers towards toward 'BBB' category peers levels; or higher medium-term investment and growth rates without the creation of macroeconomic imbalances, such as from successful structural reform implementation and a healthier financial sector. 

The rating agency said fiscal metrics are also showing signs of improvement and it expects the general government deficit to narrow to 10.6% of GDP in FY22, from 13.6% in FY21. “This is consistent with an FY22 central government deficit of 6.9% of GDP, excluding divestment receipts. Per the government's deficit definition, including divestment, this would be 6.6% of GDP, which is slightly below the budget target. Strong revenue growth, particularly from goods and services tax collections, is facilitating the government to stay within its budget parameters, despite modest additional spending pressure from the second pandemic wave," it added.  

Fitch projected India’s GDP growth at 8.7% for FY22 and 10% in FY23, to be supported by the resilience of India's economy, which has facilitated a “swift cyclical recovery" from the Delta covid-19 variant wave in the first quarter of FY22. “Mobility indicators have returned to pre-pandemic levels and high-frequency indicators point to strength in the manufacturing sector. The potential remains for a resurgence in coronavirus cases, though we anticipate the economic impact of further outbreaks would be less pronounced than previous surges, particularly given the sustained improvement in the covid-19 vaccination rate, which has now surpassed 1 billion doses administered," it added.  

The rating agency said India's strong medium-term growth outlook relative to peers is a key supporting factor for the rating and an important driver of its current baseline of a modestly declining public debt trajectory. “We forecast growth of around 7% between FY24 and FY26, supported by the government's reform agenda and the closing of the negative output resulting from the pandemic shock. The government's production-linked incentive scheme to boost foreign direct investment, labour reform and the creation of a 'bad bank', along with an infrastructure investment drive and the National Monetisation Pipeline, should support the growth outlook if fully implemented. Nevertheless, there are challenges to this outlook, given the uneven nature of the economic recovery and reform implementation risks," it cautioned.  

Fitch said it believes immediate financial-sector pressure has eased, in part due to regulatory forbearance measures that are providing banks with time to rebuild capital buffers. “The level of asset quality deterioration from the pandemic, while masked by forbearance relief, also appears less severe than we had anticipated. The recently incorporated National Asset Reconstruction Company (bad bank) could help banks address our expected build-up of impaired loans, while sustaining adequate credit growth, though more details are needed to fully assess its potential. Still, we expect credit growth to remain constrained, averaging at 6.7% yoy over the next several years, unless adequate recapitaliasation can mitigate the risk aversion currently seen among banks," it added.  

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