Fitch downgrade to hit India's image as investment destination

NEW DELHI: Fitch's downgrade of its outlook on the Indian economy comes close on the heels of S&P last week unveiling a report which strongly criticised the government's inability to move ahead with economic reforms and referred to cracks in the ruling coalition that were holding up progress.

Disappointing news about the state of the Indian economy has hit the headlines with regularity as growth has slowed and inflation stayed stubbornly high, leaving the government on the backfoot over its handling of the economy.

Fitch and S&P's actions raise the risk of Indian bonds slipping into the junk category, hurting India's image as an investment destination. The cost of overseas borrowing for Indian companies could also go up.


Fitch said general elections due in early 2014 could see politically driven pressure to loosen fiscal policy, which could further weaken India's public finances relative to peers. "The outlook revision reflects heightened risks that India's medium to long-term growth potential will gradually deteriorate if further structural reforms are not hastened, including measures to enhance the effectiveness of the government and create a more positive operational environment for business and private investments," Fitch said.

"The negative outlook also reflects India's limited progress on fiscal consolidation and, in particular, on reducing the central government deficit despite improvement in the financial health of state governments," the agency said. Fitch has, for now, retained India's BBB-(minus) which is the lowest investment grade rating.

"Against the backdrop of persistent inflation pressures and weak public finances, there is an even greater onus on effective government policies and reforms that would ensure India can navigate the turbulent global economic and financial environment and underpin confidence in the long-run growth potential of the Indian economy," said Art Woo, director in Fitch's Asia-Pacific sovereign ratings group.

Fitch, however, said that India faces an awkward combination of slowing growth and high elevated inflation and the country also faces structural challenges surrounding its investment climate in the form of corruption and inadequate economic reforms.

The agency expects GDP to rise 6.5% in FY13, down from a previous projection of 7.5% while WPI inflation is expected to rise by an average of 7.5% in FY2012-13 "which, though lower than the 8.8% rise in FY2011-12, continues to be higher and stickier than previously expected, diminishing scope for monetary policy flexibility."

The agency expressed doubts about the government's ability to meet the fiscal deficit target of 5.1% of gross domestic product set for 2012-13. "The confluence of weaker economic growth and a large subsidy bill means India will likely miss its 5.1% of GDP deficit target for FY2012-13; Fitch expects it to be 5.6%-5.9% of GDP," the agency said.

Reacting to the downgrade, finance minister Pranab Mukherjee said the ratings agency had not taken note of many recent structural reforms initiatives taken by the government - such as UIDAI, fertilizer subsidy reform, capping subsidies as a fraction of GDP, the new manufacturing and telecom policies. "The concerns expressed by Fitch on the economic growth potential, inflationary pressures, and weak public finances are based on earlier data. Government has already taken note of such concerns," Mukherjee said in a statement.

He repeated the same positive trends that he had listed when S&P had issued its stinging report last week. The finance minister said the decline in international oil prices in recent weeks and absence of any major adverse results on corporate performance in the last quarter of 2011-12 are all factors that would have a positive impact on the government's fiscal position and more generally on India's economic growth.

"In view of the above, although government welcomes the observations made by Fitch Ratings regarding the strong fundamentals of the Indian economy, its concerns about the economic growth, inflationary pressures, and weak public finances are not placed in the context of the present state of the global economy and are based on older data," Mukherjee said.