Credit impact of Indian Budget hinges on growth outlook: Fitch

Hong Kong, February 11 : India's Budget presented by the government on February 1 points to a loosening of fiscal policy to support the country's ongoing economic recovery from the pandemic and will consequently lead to a rise in public debt, Fitch Ratings said on Thursday.
"The debt/GDP trajectory is core to our sovereign rating assessment, meaning higher deficits and a slower consolidation path will make India's medium-term growth outlook take on a more critical role in our analysis," it said.
India entered the pandemic with little fiscal headroom from a rating perspective. Its general government debt/GDP ratio stood at 72 per cent in 2019 against a median of 42 per cent for BBB-rated peers.
Fitch revised the outlook on India's BBB-minus rating to negative from stable in June 2020, partly owing to our assumptions about the impact of the pandemic on its public finance metrics.
The budget's deficit projections for fiscal years ending March 2022 (FY22) to FY26 are about one percentage point a year above its previous estimates between, which can make it more challenging to put debt/GDP on a downward trajectory.
"We now expect public debt/GDP to rise above 90 per cent of GDP over the next five years, based on the revised Budget targets and with our other previous rating assumptions remaining unchanged," Jeremy Zook, said Director for Sovereigns.
"However, recent reforms and policy measures including those announced in the Budget can also influence our growth expectations and thus our debt trajectory forecasts."
Fitch's latest economic outlook projected growth at 11 per cent in FY22 then at around 6.5 per cent a year through to FY26. This pace of expansion reflects base effects and the closing of output gaps after the pandemic shock.
In aggregate, said Zook, the 2021 Budget has the potential to lift growth prospects. Higher expenditure will support the near-term recovery and increased infrastructure spending can boost sustainable medium-term growth rates.
Labour market and agricultural reforms that were legislated in September 2020 can also lift medium-term growth. However, recent adverse court rulings have highlighted implementation challenges to these reforms and there is a risk that fiscal spending could also fall short of planned levels.
Meanwhile, the Budget's proposed increases in import tariffs can dampen trade and economic growth. Although there are implementation risks around aspects of the Budget, Fitch regards the government's overall fiscal projections as broadly credible.
The Budget's higher deficit forecasts are partly driven by positive steps toward greater transparency as previously off-balance-sheet items like loans from the Food Corporation of India have been brought on Budget.
The extent to which policy changes address weaknesses in India's financial sector will also influence the country's medium-term growth potential.
"We believe the proposed injection of Rs 20,000 crore of new capital into state banks will be insufficient to alleviate the anticipated incremental stress on capital levels in 2021 and 2022," said Fitch.
"State banks are likely to continue to experience asset-quality problems, weak profitability and small capital buffers and, as a result, we project credit growth to remain soft in the absence of further government action."
On the other hand, the proposed establishment of an asset reconstruction company and an asset management company to deal with bad banking sector assets should be credit positive, dependent on the details of its structure and implementation.
Plans to privatise two state banks can also be significant but will require changes to the Bank Nationalisation Act, which will add to implementation challenges.
Fitch said it will take a considered view of any changes to the Act and take necessary action should these have broader implications for the sector or our support assumptions.