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S&P cautiously optimistic on India outlook

The euphoria in the market over the speculation that Standard & Poor’s (S&P) might upgrade India’s rating might be over-hyped, as the agency showed “cautious optimism” in its meeting with the finance ministry last month. As concerns over an over-optimistic tax collection target and lack of subsidy reforms remained, S&P might scale up outlook on its India ratings from negative to stable instead of an upgrade.

S&P currently rates India as ‘BBB-‘, considered lowest investment grade by market participants. An upgrade of rating would push India to ‘BBB’ rating. Both the ratings are part of BBB category, which signifies adequate capacity of the government to meet financial commitments, but this is prone to adverse economic conditions. The highest rating within BBB category is ‘BBB+’.

However, if the outlook is upgraded to stable, India might remain at ‘BBB-‘, but downward risks might even out upward parameters. This means that India will have equal chances to remain in this grade in the medium term.

The outlook upgrade itself could potentially boost investors’ sentiment and encourage foreign inflows.

“Measures so far announced by the government are encouraging in terms of direction and we expect that these will add to positive sentiment, boosting investment. However, details about how the government will be able to generate economic growth of seven-eight% as flagged in the Budget are lacking, and the approach to boost FDI (foreign direct investment) seems rather cautious,” Agost Benard, associate director of Sovereign Ratings at S&P, said in response to an e-mail query from Business Standard. In his Budget speech, Finance Minister Arun Jaitley had talked about pushing up economic growth to seven-eight% in the next three-four years against sub-five% in the previous two financial years.

Though India, as always, pitched for a rating upgrade arguing the economy was on growth path and fiscal deficit was in control, it is learnt that the S&P team was worried that the Budget estimate of 20% growth in tax mop-up would be difficult to meet.

The direct tax collection target for 2014-15 has been fixed 15% higher at Rs 7.36 lakh crore. The growth in 2013-14 was 14%. Indirect tax collections are expected to increase 26% to Rs 6.24 lakh crore, against a meagre growth of 4.6% in the previous year. The target appears very high to analysts but the finance ministry is pinning its hopes on 5.8% gross domestic product (GDP) growth this year.

“We told them, with growth picking up tax collections would improve. They asked about subsidies, too. We made it clear the room was limited but the government is trying to improve efficiencies. Subsidies can’t go away overnight,” said a finance ministry official, who did not wish to be identified.

Major subsidies, including food, fertiliser and petroleum, are pegged at Rs 2.5 lakh crore this year, against Rs 2.4 lakh crore last year. The government has set up a commission to suggest the road map for expenditure reforms, including subsidy reduction.

“The new administration’s commitment to maintain fiscal consolidation by progressively reducing central government fiscal deficits is a positive step on improving the credit metrics of India’s sovereign rating. The fiscal policy stance has been a constraining factor for India’s sovereign ratings for some time. Therefore, if the authorities can deliver on their fiscal goals, resulting in a lower debt and interest burden that would benefit India’s credit fundamentals,” Benard added.

Government officials said compared to other rating agencies, S&P was more pessimistic on India, and that it focused more on fiscal consolidation than other economic indicators.

Fitch, Moody’s and JCRA (a rating agency from Japan) are expected to meet finance ministry officials in the coming months.

“The Indian economy is on upward trajectory and this has been noticed globally and therefore, I am quite confident that the rating agencies will notice this,” said Finance Secretary Arvind Mayaram recently.

The data so far has been showing mixed signals. Indian economy grew at 5.7% in April-June quarter this year – the highest in over two years. For the full year, the government expects a growth of 5.8-5.9%. Current account deficit narrowed down to 1.7% in the first quarter, against 4.8% a year ago. Wholesale inflation declined to a five-month low of 5.19% in July, against 5.43% in June, and 5.84% in July last year.

However, the Centre’s fiscal deficit is pegged at 4.1% of GDP of the current financial year against 4.6% witnessed in the previous year. The deficit has already crossed 10% of GDP in the first quarter and stood at over 60% of the Budget estimates in just four months. The government is optimistic about meeting the target, saying expenditure far outpaces revenues in initial months.

Besides, infrastructure output growth slowed to three-month low of 2.7% in July. Manufacturing activity, as per HSBC India Manufacturing PMI, declined from 53 in July to 52.4 in August. Also, PMI services declined to 50.6 in August from 52.2 in the previous month. Industrial output fell to 3.4% from the previous month’s revised estimate of five%. Retail inflation rose to 7.96% in July from 7.46% the previous month.

Last month, Franklin Templeton had pumped in about Rs 16,000 crore into the Indian debt market, fuelling speculations of an upgrade of India’s ratings.

Two years ago, when S&P downgraded India’s outlook to negative from stable, it had said the economy had one-in-three chances that it could be downgraded to “junk” status over the next two years “if the external position continues to deteriorate, growth prospects diminish, or progress on fiscal reforms remains slow in a weakened political setting”.

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