Strong external finance is likely to limit the impact of rupee weakening against the US dollar on the country’s sovereign rating profile, global rating agency Fitch said on Monday. This report has come at a time when the rupee breached the 70 level against US dollar last week. However on Monday it opened strong at 69.83 per dollar, a gain of 32 paise versus its previous close of 70.15.

In April this year, Fitch retained India’s sovereign rating at ‘BBB-’ with ‘stable’ outlook, saying that the country’s medium-term growth potential is strong. A ‘BBB-’ rating indicates the lowest investment grade, while a ‘stable’ outlook reflects the assessment that upside and downside risks to the ratings are broadly balanced.

The report mentioned that the rupee has lost approximately 9 per cent during this calendar year and is ‘the worst-performing major currency in Asia’. The pressure on the rupee mounted after the Turkey crisis. “Idiosyncratic factors have also contributed, such as the widening of the trade deficit in July 2018 to its largest gap since May 2013. Net portfolio outflows through mid-August have totalled $5.5 billion for the year, mostly in bonds, compared with inflows of $27.9 billion over the same period in 2017. Foreign direct investment inflows have also weakened and no longer cover the current account deficit - in other words, India's basic balance has turned negative,” it said.

Despite these, the agency feels that India's vulnerability to currency risk and capital outflows is unlikely to translate into significant pressure on the sovereign credit profile or pose external financing risks. The current account deficit has widened as global oil prices have risen, but at 1.9 per cent of GDP in 1Q18, up from 1.6 per cent in 2017, it was still well below the 5 per cent of GDP recorded around the time of the 2013 Taper Tantrum.

“We expect the full-year current account deficit to remain below 3 per cent of GDP in the fiscal year ending March 2019. Foreign-exchange reserves have declined by $24 billion since mid-April 2018, but still cover 7.2 months of current account payments, compared with the 'BBB' median of 6.6, providing a buffer should the Reserve Bank of India feel it necessary to intervene on a larger scale,” it said.

India also has a relatively low foreign-currency debt. Only around 7 per cent of government debt is denominated in foreign currency, while the total foreign-currency external debt, including the private sector, is equivalent to just 13 per cent of GDP, which is one of the lowest among major emerging markets.

Meanwhile, the risk of currency pressures triggering a sudden spike in domestic borrowing costs is mitigated by the RBI's relatively narrow focus on its inflation objective, as opposed to countering external pressures. This is in contrast to the approach in Indonesia, for example, where the central bank has responded to currency pressures with aggressive interest rate increases. External pressures may be enough to prompt another 25bps hike this year, but dramatic moves by the RBI to defend the currency appear unlikely in Fitch's view.

India's corporate sector is less dependent on foreign borrowing than in most other emerging markets, but hedging practices are limited, particularly at companies lower down the credit scale. The most vulnerable companies are likely to be those with significant foreign-currency debt, and which operate in sectors with significant imported/ commodity inputs and revenue denominated in local currency - such as the airline, telecom, auto, chemical and fertiliser sectors. Most Fitch-rated corporates are unlikely to be significantly affected, as those with foreign-currency debt tend to have a natural hedge from export earnings, as in the case of commodity producers.

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