Downside risks to India ratings remains as deficit cuts slower than peers

Finance Minister Arun Jaitley has stayed on the course of FRBM path to target a lower fiscal deficit of 3.5 per cent for FY17 without compromising on its development agenda. The Budget announced a raft of new schemes for the poor and hiking allocations for infrastructure. Speaking to Bloomberg TV India , Standard & Poor’s director for sovereign ratings, Kyran Curry, says the pace of fiscal consolidation is relatively modest compared with India’s peers. The downside risk to India remains, given its relatively low per capita GDP and relatively weak fiscal settings, he warned.

We are not surprised. We expected some slippage in the fiscal target this year. But, what it says is that the government momentum of fiscal consolidation remains relatively weak. We observed that there is a clear policy priority spending on rural and regional India. And at the same time, the government is making a lot of effort to increase spending on infrastructure. All these initiatives work towards raising India’s growth prospects and somewhat stabilising the fiscal position; and the fact that the fiscal deficit this year remains at 3.5 per cent, the pace of fiscal consolidation is relatively modest compared to India’s peers.

Is it a disappointment that the Budget did not clearly announce any structural reform, especially on taxation and expenditure fronts?

We see India as having a history of revenue under-performance. And if there is one thing that might weigh on the ratings, it is the revenue numbers, particularly if growth weakens in the medium term and puts pressure on the government’s fiscal position. We see a history of India in revenue under-performance and we won’t be surprised to see perhaps some slippage in the fiscal deficit numbers in the year ahead.

The disinvestment target still remains extremely high at his point and the worry is that these one-offs help sometimes to bridge the fiscal deficit. But we worry there is too much reliance to make consolidation work through these one-offs?

That’s right. One-offs provide some support and they do tell us that the government is willing to make some potentially difficult decisions to stabilise the fiscal position. But, expenditure restraint or further efforts to either broaden the revenue collection base or raise revenues tend to stabilise the government operating position. This is the sort of thing that we would be looking for in the Budget.

They also held back any additional funding for PSU banks, which was a big disappointment. Are you worried about a systemic risk? As the RBI governor talked about resolving the problem of stressed loans and cleaning up banks’ balance sheet by 2017. Are you confident of that? Do you feel there is further risk to the system?

We expected there will be further recap cost for the government. We took more or less a negative view last year about the potential recap and we expected the government to bear a higher burden for transferring more funds into the banks. Fundamentally, you have to keep in mind that the banking system in India is in relatively good shape. It may have some challenges in the public sector in meeting Basel-III capital requirement, but fundamentally, banking system is able to support India’s growth as it is adequately capitalised; it’s profitable and is broadly equipped and is not dependent on external savings to fund its growth. So we don’t see material risks to the banking system or if I want to extend that further, to the sovereign credit quality itself.

What are you worried about India’s rating right now?

The downside risk to India remains its relatively low per capita GDP and relatively weak fiscal settings. Against that, the fact is India is a very robust democracy with very deep and robust institutions, and external position is looking relatively good and the RBI is a respected central bank. For us to see further upside to ratings, we need to see material gains in the government’s fiscal position. We were expecting to see a material gain or a path to material gain to see some upside to the ratings. But, for the moment we don’t see that.

Is there is a risk if there is a change in monetary policy regime when the Monetary Policy Committee is set up?

We rate the RBI as being a fine institution. The adoption of an inflation-targeting regime or developing an MPC will modernise the operations of the RBI. And that will be a continued support for the sovereign rating of India, going forward. We don’t see any downside risks relating to the operations of RBI, nor the manner in which it conducts its monetary policy.