Global credit rating agency Moody's Investors Service on Monday said India's credit profile is supported by its strong growth potential, high private savings enabling access to funds for the government at favourable terms.
On the other hand Moody's said these credit strengths were balanced against high government debt -- 67.4% of gross domestic product -- regulatory and infrastructure constraints, slow pace of reform and the contingent liability risk to the sovereign from public sector banks' high and rising non-performing loans.
"Over the past year, external developments favourable to India such as lower global oil prices have combined with policy measures -- including tighter or less accommodative fiscal and monetary policies than in the past -- to move the economy towards a more stable macroeconomic development with smaller fiscal deficits, lower inflation and a narrower current account deficit," Moody's said in its annual credit analysis of India.
However, one short-term consequence of the policy setting, combined with two successive unfavourable monsoon last year and the year before, has been relatively moderate nominal GDP growth, the agency added.
Moody's expects corporates' profitability to remain muted which will continue to dampen their ability and willingness to invest in the next few quarters.
"We forecast real GDP growth at around 7.5% in the next two years. In nominal terms, we do not expect GDP growth to rise above 10% until FY2017," Moody's said.
According to Moody's, sustained fiscal consolidation, stable inflation at moderate levels and progress on reforms aimed at enhancing the business environment would contribute to sustained growth at robust levels.
In turn, persistent income and profit growth would raise government revenues and contribute to improved fiscal metrics.
While India has institutional strength of checks and balances there are offsetting weaknesses like an uncertain regulatory environment, corruption, a slow-moving judicial system and, in general, inefficiencies in the delivery of government services.
Moody's said political fragmentation leads to slow and ad-hoc progress on reforms. Progress on land and labour reforms, when it has occurred has been limited and gradual.
According to Moody's India's Susceptibility to Event Risk is driven by banking sector risk.
As banks continue to recognise bad assets, non-performing loans will rise further, particularly for public sector banks, albeit at a slower pace than at the end of 2015.
The focus on bad asset recognition and provisioning in the banking system as well as the recent passage of a new bankruptcy bill would be credit positive from a sovereign perspective, if it led to improved bank capitalisation levels, renewed loan growth and robust risk processes, Moody's said.
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