Fitch affirms Kerala’s rating at BB with stable outlook

“We expect GST to stabilise, which will augment Kerala's revenue capacity as the tax base expands with greater efficacy. GST compensation, through the transfer of income from the central government to cover potential losses in tax revenue, will also smooth state finances," Fitch said in a statement.

This comes after all three big rating agencies have graded one of their lowest investment grades for India because of the coronavirus crisis. While Fitch has recently revised India’s outlook to negative from stable, Moody’s Investors Service and Standard and Poor’s (S&P) have downgraded the country’s sovereign rating to BBB-, the lowest grade possible.

In June, S&P had downgraded the long-term credit rating for Kerala to BB- from BB with a stable outlook holding that it expects the state’s already-weak fiscal metrics to deteriorate significantly in the wake of the severe economic shock brought on by the coronavirus pandemic.

Fitch said Kerala’s total revenue has increased in the last four years even as lockdowns and restrictions imposed in the wake of the coronavirus pandemic have damaged the state's economic and fiscal performance. It holds the fiscal position to drop in this year and begin recovery from 2021 onwards.

“Kerala's gross regional product (GRP) rose by 11.4% in the fiscal year ended March 2019 (FY19) at current prices to INR7.8 trillion following a four-year FY15-FY19 CAGR of 10.4%. We estimate FY20 GRP at INR8.7 trillion. Kerala's total revenue increased at a four-year FY15-FY19 CAGR of 12.5%, faster than its GRP," the rating agency said.

“The state has stable revenue sources, as its tax and non-tax revenue accounted for 67% of operating revenue in FY19, higher than the all-state average of 55%," it added.

Fitch cautioned that the state’s constrained revenue options in the pandemic situation, surging debts and a negative impact on the credit profile owing to exposure to several natural disasters, including landslides and flooding.

“Our 'Weaker' assessment of revenue adjustability reflects the central government's power to set major taxes, the formula-driven and stable transfer regime, and the state's limited political capacity to substantially raise local tax rates due to legislative and populist pressure," it said. In last year’s budget, Kerala had increased tax on new motorcycles, cars and private-service vehicles by 1% and tax on the sale of foreign liquor by 2%.

Kerala leads other Indian states in demographic and human development indicators relating to health, education, and gender equality, and spends considerably on socio-economic programmes. “Total expenditure rose at a FY15-FY19 CAGR of 11.8%, in line with the 12.5% CAGR of total revenue growth, showing robust control over expenditure under a balanced budget. Capex only accounted for 8% of total expenditure in FY19, despite a faster 18.2% FY15-FY19 CAGR against operating expenditure growth of 10.2%, as the state intends to boost infrastructure development," the rating agency said.

The state has set up the Kerala Infrastructure Investment Fund Board, which has a Fitch rating of BB and stable outlook, to borrow in both national and international markets to fund its development. “Access to bank loans and the capital market widens its financing channels and liquidity pool," the rating agency said.

Fitc also expects Kerala's economic-liability burden, the primary metric of debt sustainability, to remain within 70%-90% until FY24, leading to an 'a' debt-sustainability assessment. Fitch, however, has lowered this to 'bbb' due to weak secondary metrics, ranging from a negative payback ratio (net overall risk/current balance) to a fiscal debt burden of over 250%.