New Delhi: Ahead of the first full-year budget of the Narendra Modi government to be presented on Saturday, rating agency Standard & Poor’s on Monday said improvements in India’s weak fiscal balance sheet are likely to be gradual and unlikely to lead to a rating upgrade in the next three to five years.

In a report titled Meeting reforms expectations is key to maintaining investment-grade ratings on India, the rating agency said improvement on multiple fronts such as higher growth in real per capita gross domestic product (GDP), stronger fiscal and debt metrics, a stronger external position or improved monetary policy setting, and the centre’s ability to fulfil its promises on key reforms will be critical.

While India’s last 10-year fiscal deficit (both state and centre) averaged 8% of GDP, the average fiscal deficit of its peers such as Indonesia and Brazil varied between 0.7% to 3% of GDP during the same period, S&P said, justifying a lower investment rating for India.

India has the lowest investment rating of BBB minus. But the rating agency, which had been threatening to further downgrade India to junk status, upgraded India’s sovereign rating outlook to stable from negative in September after a majority government took charge in New Delhi. The government debt of India above 65% of GDP is also significantly higher than its peers such as Indonesia (24%) and Brazil and Uruguay (50%).

However, S&P accepted that India’s sizeable debt burden imposes little exchange rate risk on its fiscal balances, as more than 90% of the public debt is denominated in rupees and held mainly by residents. “This contrasts with Indonesia or Uruguay, where external debt is close to half of the total general government debt. The Philippines and South Africa also face higher external risks than India because their external debt is about 35% of total debt."

The centre has set a fiscal deficit target of 4.1% of gross domestic product (GDP) for the year ending 31 March. In its medium term fiscal consolidation road map, finance minister Arun Jaitley in his first budget on 10 July had set the target of 3.6% of GDP for 2015-16. Though there have been demands from some quarters to loosen fiscal deficit constraints for 2015-16 and focus on boosting capital expenditure to meet the gap created by tepid private investment demand, Jaitley has hinted he will remain on course of fiscal consolidation.

Citibank India economist Rohini Malkani on Monday said in a research note that there has been chatter on the need for higher government spending to kick-start growth. “However, we expect government to broadly adhere to the fiscal consolidation path (3.6%-3.8%) largely on account of (1) on-going revenue and expenditure reforms (2) revival in the economy and (3) a benign crude outlook," she added.

S&P maintained that India’s credit metrics are weaker than most of its peers enjoying BBB sovereign rating such as Brazil, Colombia, Philippines, South Africa and Uruguay.

“Standard & Poor’s Ratings Services believes that recent improvements in the country’s political setting could herald a more conducive environment for reforms, boost growth prospects, and increase the likelihood for improved fiscal management. India’s sovereign credit indicators should therefore have a better chance of closing the gap with those of similarly rated sovereigns," it added.

The rating agency said India’s somewhat stronger external balance sheet only partly offsets its weaknesses on other fronts. “We see effectiveness of institutional and governance in India as a neutral credit factor, as is the case with other emerging market sovereigns in this rating category. We also assess India’s monetary flexibility to be moderately supportive of sovereign creditworthiness," S&P said.

However, S&P maintained that India has the highest domestic savings and investment rates among the peers, averaging 30% of GDP and 32% of GDP, respectively, over the past 10 years.

“This factor, along with the country’s favourable demographics (87% of the population is aged 54 or below), puts India in good stead to achieve the faster growth needed to catch up with wealthier countries. However, India’s projected per capita GDP of US$2,404 by 2017 will still leave the country’s wealth at about one-third of the average for similarly rated countries," it added.

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