Global rating agency Fitch Ratings on Wednesday upgraded India's long-term foreign currency rating to 'BB+' from 'BB' and affirmed the long-term local currency rating at 'BB+.'
The outlook on the ratings is 'stable.'
The upgrade reflects India's strengthening balance of payments position and rapidly improving external balance sheet. However, poor fiscal performance continues to constrain the ratings, Fitch said in a media release.
Over the past few years, India's balance of payments has strengthened considerably owing to booming services exports -- primarily in IT and IT-related sectors -- and healthy remittances, Fitch said.
"Combined with buoyant foreign portfolio capital inflows and a steady influx of Non-Resident Indian deposits, this has led to a sharp increase in official foreign currency reserves which have nearly doubled since December 2001 to over $100 billion. As a result, India's external liquidity ratio has improved to 163 per cent in 2003-04 from 110 per cent in 1998-99 and is projected to rise further to 227 per cent in 2004-05," Fitch added.
Fitch noted that while recent capital inflows may partially reflect low global interest rates, software exports should continue to support the current account of the balance of payments over the medium term.
India's external debt ratios have also improved dramatically, thanks to increases in current external receipts and prepayments of expensive public external debt. Gross external debt has fallen to 113 per cent of current external receipts in 2002-03 from almost 200 per cent in 1995-96, said Fitch.
Net external debt has fallen even faster to 32 per cent of current external receipts from almost 150 per cent over the same period thanks to accumulating foreign exchange reserve assets. Net external debt / current external receipts are expected to continue falling to just 1 per cent by end 2004-05, raising the prospect of India achieving net external creditor status in the medium term, Fitch said.
India's vulnerability to external shocks and the balance of payments constraint on growth have both eased significantly, Fitch said.
However, the rating agency noted that the poor state of public finances remains a major constraint on India's credit ratings. The general government deficit at 10 per cent of GDP (gross domestic product) is three times the 'BB' median.
"General government debt reached over 80 per cent of GDP in 2002-03 -- compared to a 'BB' median of 49 per cent - and is expected to increase further unless significant fiscal consolidation is pursued. The risks of a fiscal financing crisis over the medium term are mitigated by most of the government debt being held domestically, denominated in rupee and bearing long maturities," said Fitch.
With GDP growth picking up and domestic interest rates having declined, adverse public debt dynamics will remain 'slow burn' in the near term, Fitch said.
Fitch warned that India cannot rely on such a favourable macro picture for too long and needs decisively to cut fiscal deficits to stabilize its debt burden.
The failure to take advantage of strong macroeconomic conditions to commence fiscal consolidation this fiscal year, with the government announcing further tax cuts, was unfortunate, said Fitch.
Fitch acknowledged that India has made progress in opening up the economy in recent years, reducing external tariffs, responding to the crisis in the power sector and improving India's infrastructure.
But, the rating agency said, the broader pace of structural reform was disappointingly slow in the areas of privatisation, labour market reform and tax reform. This seems partly to reflect unwieldy coalition politics and the need for broad based consensus building.
The pace of reform would need to accelerate sharply in order to push India on to a path of sustainable medium term growth in excess of 6 per cent, Fitch concluded.
