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India faces structural challenges surrounding its investment climate in the form of corruption and inadequate economic reforms, the ratings agency said
Fitch Ratings said it revised India's outlook to negative from stable due to heightened risks to India's medium to long term growth potential.
"Against the backdrop of persistent inflation pressures and weak public finances, there is an even greater onus on effective government policies and reforms that would ensure India can navigate the turbulent global economic and financial environment and underpin confidence in the long-run growth potential of the Indian economy," said Art Woo, director in Fitch's Asia-Pacific Sovereign Ratings group.
The ratings agency said its outlook revision reflects heightened risks that India's medium- to long-term growth potential will gradually deteriorate if further structural reforms are not hastened, including measures to enhance the effectiveness of the government and create a more positive operational environment for business and private investments.
"The negative outlook also reflects India's limited progress on fiscal consolidation and, in particular, on reducing the central government deficit despite improvement in the financial health of state governments," it added.
Fitch Ratings affirmed India's long-term foreign- and local-currency issuer default ratings (IDRs) to BBB-, short term foreign currency ratings at F3 and country ceiling at BBB-.
The rating affirmation reflects India's diversified economy and its high domestic savings which reduce reliance on foreign investors for private investment and fiscal funding. The Indian government is able to issue long-term debt at a low cost in its own currency. Net external debt is very low and still high foreign exchange reserves of the Reserve Bank of India (RBI) provide a cushion against potential external shocks. The underlying drivers of the last decade of rapid economic growth remain in place - a fast growing pool of educated workers and an innovative private services sector, it said.
Fitch, however, notes that India faces an awkward combination of slowing growth and still-elevated inflation. Real GDP grew just 6.5% year-on-year (yoy) in FY12, down from an 8.4% rise in FY11. India also faces structural challenges surrounding its investment climate in the form of corruption and inadequate economic reforms.
Fitch forecasts real GDP to rise 6.5% yoy in FY13, down from a previous projection of 7.5%. Headline wholesale price index (WPI) rose 7.6% yoy in May 2012, up from 7.2% yoy in April. Fitch is projecting WPI to rise by an average of 7.5% in FY13 which, though lower than the 8.8% rise in FY12, continues to be higher and stickier than Fitch previously expected, diminishing scope for monetary policy flexibility.
India's public finances are a key rating weakness compared with other 'BBB'-rated sovereigns, which constrains scope for fiscal policy flexibility. Fitch estimated general government debt stood at 66% of GDP at end-FY2011-12, against the 'BBB' median of 39%. Moreover, India's government revenue in-take is low at 19.4% of GDP.
The central government fiscal deficit climbed to 5.8% of GDP in FY2011-12, against a target of 4.6%, largely reflecting an overshoot in subsidy spending. The government has repeatedly delayed reforms to the tax and subsidy systems. The confluence of weaker economic growth and a large subsidy bill means India will likely miss its 5.1% of GDP deficit target for FY2012-13; Fitch expects it to be 5.6%-5.9% of GDP. General elections due in early 2014 could see politically driven pressure to loosen fiscal policy, which could further weaken India's public finances relative to peers, the ratings agency added.
India's external financial position remains a rating strength, although this is eroding as foreign exchange reserves have fallen at 11% since August 2011 and net external indebtedness is rising. Reserves remained at $286 billion as of end-May 2012, equal to six months of current external payments, which still provides the sovereign with an important buffer during periods of elevated global risk aversion. The sovereign is a net external creditor to the tune of 10.2% of GDP at end-FY2011-12, against the 'BBB' median of 3.3% of GDP or the 'BB' median of negative 4.1% of GDP.
According to the ratings agency, slowing growth should curb India's current account deficit and slow the weakening of the external finances, although oil prices pose a risk. Prolonged and intensified pressure on the currency and/or foreign reserves would be negative for the credit profile.
A significant loosening of fiscal policy, which leads to an increase in the gross general government debt/GDP ratio, would result in a downgrade of India's sovereign ratings. In addition, a material downward revision of Fitch's assessment of the India's medium-term growth potential along with persistent high inflationary pressure would hurt India's sovereign creditworthiness.
Conversely, an improvement in India's investment climate, which supports greater infrastructure investment and a sharp sustained decline in inflation, would be supportive for India's sovereign ratings. Fiscal consolidation and structural budget reform would also support the ratings, Fitch added.
Nifty has to stay above 5,045 for the upmove to continue
The market closed in the positive for the second week in a row on hopes that the Reserve Bank of India (RBI) will cut key rates in its mid-quarter policy review on 18th June. Besides, there are speculations that central banks across the world would draw up new initiatives to control any financial chaos in the aftermath of Greek elections to be held on 18th June.
Overall, the market gained 1% with the Sensex closing the week at 16,950, up 231 points, and the Nifty gained 71 points to settle at 5,139. On Friday the Nifty recorded an intraday high of 5,146 which was its best since 4 May 2012. If the benchmark stays above 5,045, it could go up to the level of 5,280 else we may see it going down to the level of 4,900.
The market started the week in the negative on remarks by ratings agency S&P that India would be the first among BRIC nations to lose its investment grade rating. The market closed in the positive for the next two days on optimism of a rate cut by the RBI. The indices settled lower on Thursday as high inflation numbers pulled down rate-sensitive sectors. Positive sentiments, once again, pushed the benchmarks higher on the last trading day of the week.
The BSE Fast Moving Consumer Goods and BSE IT gained 3% each while the BSE Realty index fell by 2% and the BSE Healthcare index slipped by 1%.
Among Sensex stocks, Hindustan Unilever (up 5%), Infosys, Coal India, ITC and TCS (up 4% each) were the top gainers. On the other hand, NTPC (down 4%), Dr Reddy's Laboratories (down 3%), Maruti Suzuki, Wipro and HDFC (down 1% each) settled at the bottom of the index.
The top gainers on the Nifty this week were Ambuja Cements (up 12%), Grasim Industries (up 8%), ACC (up 7%), BPCL (up 6%) and HUL (down 5%). The major losers were NTPC (down 4%), Bank of Baroda, Dr Reddy's, SAIL (down 3% each) and Ranbaxy (down 2%).
India's industrial growth, as measured by the Index of Industrial Production (IIP) slowed down sharply to 0.1% in April due to contraction in capital goods and dip in manufacturing output. Growth in factory output was 5.3% in April last year.
Headline inflation moved up to 7.55% in May on account of a rise in prices of potato, pulses and wheat. Inflation, as measured by the Wholesale Price Index (WPI), was 7.23% in April. In May last year, however, it was 9.56%. Food inflation, which has a 14.3% share in the WPI basket, rose to 10.7% in May, from 10.5% in the previous month.
India's exports declined by 4.16% to $25.68 billion in May due to unabated slump in global demand and a slowdown in domestic industrial growth. Imports dropped by a sharper pace of 7.36% to $41.9 billion, signalling weakening of the economy. The trade deficit also narrowed to $16.3 billion during May, from $18.5 billion a year ago.
On the global front, all ayes will be on the outcome of the Greek elections and hopes that US Federal Reserve will announce new measures to boost the country's economy. Leaders from the Group of Twenty (G20) nations, who are scheduled to meet next week in Mexico, said central banks were ready to provide liquidity and avert any credit squeeze if the market is under pressure after Sunday's election in Greece.