India's economy may experience a record contraction in the current financial year mainly due to the global Covid-19 pandemic, and the real GDP growth is expected to recover from next fiscal onwards, according to a report by global rating agency S&P.
India's weak fiscal settings will worsen further this year, constraining the government's ability to aid the economy, it said.
However, it said the country's external settings have improved, helped by the rapid accumulation of foreign exchange reserves.
"We are affirming our 'BBB-' long-term and 'A-3' short-term foreign and local currency sovereign credit ratings on India.
"The stable outlook reflects our view that India's contraction in fiscal 2021 will be followed by a significant recovery, which will stabilise the country's broader credit profile," it said.
The sovereign credit ratings on India reflect the economy's above-average long-term real GDP growth, sound external profile and evolving monetary settings, it said.
"India's economy will experience a record contraction in fiscal 2021 (year ending March 31, 2021), largely owing to the global Covid-19 pandemic. We expect real GDP growth to recover from fiscal 2021 onwards," the global rating agency said.
India's democratic institutions promote policy stability and compromise, and also underpin the ratings, it said.
The agency added that these strengths are balanced against vulnerabilities stemming from the country's low per-capita income and weak fiscal settings, including consistently elevated general government deficits and indebtedness.
The report further said it may lower the ratings if India's economy recovers significantly slower than the expectation from fiscal 2021 onwards or net general government deficits and the associated accumulation of indebtedness materially exceed our forecasts.
Observing that India's worsening Covid-19 situation and the strict measures to contain it have hit the economy hard, the rating agency said productive capacity has been severely disrupted since the start of the pandemic.
While India's economy continues to outperform peers at a similar level of income on a 10-year weighted average real GDP per-capita basis, its performance on this metric has weakened somewhat, it said.
"Prior to the onset of the Covid-19 pandemic, the Indian economy had already slowed measurably," it said.
It added existing vulnerabilities, including a weakened financial sector, rigid labour markets and weak private investment, could hamper the economic recovery, especially in view of the deep downturn this year.
S&P noted that the government's reluctance to provide greater direct fiscal support to the economy likely reflects pre-existing fiscal constraints, owing to years of high fiscal deficits.
"Although additional stimulus may help to avert a steeper downturn this year, it would also further strain the government's weak finances," it said.
The rating agency added the increasingly tenuous balance may challenge India's capacity to maintain sustainable public finances and balanced economic growth, if the recovery is slower than anticipated.
The government's ability to deliver and execute additional economic reforms, especially those that spur investment and job creation, will be important for India's ability to recover from the economic slowdown, it said.
Nevertheless, it said fresh fiscal revenue generating measures will be difficult to implement in the face of the current downturn.