Global ratings agency Standard and Poor's on Thursday affirmed India's sovereign rating at 'BBB-' with stable outlook, saying the country's GDP growth is likely to gradually recover towards longer-term trend rates over the next two to three years.
'BBB' rating refers to adequate capacity of the rated entity to meet its financial commitments.
"Despite a notable deceleration in India's economy in recent quarters, we believe its structural growth outperformance remains intact. Real GDP growth is therefore likely to gradually recover toward longer-term trend rates over the next two to three years," S&P said in a statement.
It expects the economic growth rate to improve to 6 per cent during 2020-21, 7 per cent in the next fiscal and 7.4 per cent thereafter.
"We expect India's economy to continue to outperform peers at a similar level of income, despite a recent slowdown in real GDP growth.
"Supportive monetary, fiscal, and cyclical factors should support economic recovery, with real GDP growth averaging 7.1 per cent in fiscals 2020-2024," it said.
The agency, however pointed out that India's fiscal position remains precarious, with elevated fiscal deficits and net government indebtedness.
Fiscal deficits have exceeded the government's plan, S&P said, adding it expects limited consolidation over the next few years.
"S&P Global Ratings affirmed its 'BBB-' long-term and 'A-3' short-term unsolicited foreign and local currency sovereign credit ratings on India. The outlook on the long-term rating is stable," it said in a statement.
As per the National Statistical Office (NSO), India's GDP growth is estimated to slow down to 5 per cent during 2019-20. The government expects growth to rebound to over 6 per cent in the next financial year.
Providing rationale for its rating action, S&P said the ratings on India reflect the country's above-average real GDP growth, sound external profile, and evolving monetary settings.
As per the statement, the stable outlook reflects S&P's expectation that India's growth will be strong, the country will maintain its sound net external position, and its fiscal deficits will remain elevated but broadly in line with its forecasts over the next two years.
Further, "upward pressure" on the ratings could build if the government significantly curtails its fiscal deficits, resulting in lower net indebtedness at the general government level. Upside potential on the ratings could also increase if India's external accounts strengthen substantially.
Also, the downward pressure on the ratings could emerge if India's GDP growth falls well below the agency's forecasts, causing it to reassess view of trend growth; net general government deficits rise further from their currently elevated levels; and political developments materially undermine economic reform momentum.
S&P further said the Indian economy has slowed measurably. Real GDP growth fell to a more than six-year low of 4.5 per cent in the second quarter of this fiscal. This was the fifth consecutive quarter of decline in year-on-year growth rate.
It also noted that tighter lending conditions continue across the financial system, particularly in the public sector.
This, it said, is reflected in a gradual decline in credit growth.
In combination with ongoing liquidity concerns in the non-bank financial institution (NBFI) sector following the September 2018 default by Infrastructure Leasing and Financial Services Ltd (IL&FS) and subsequent relatively less impactful defaults, domestic credit conditions have been somewhat mixed, it said.
"Weaker sentiment in the NBFI space may limit private consumption growth over the coming quarters," it said.
The government's August 2019 announcement that it will consolidate major public sector banks may also constrain credit growth over the next 12-24 months, it said.
"Nevertheless, we believe India is experiencing a cyclical, rather than a structural, economic slowdown. The economy's long-term outperformance highlights its resilience.
"India's wide range of structural trends, including healthy demographics and competitive unit labor costs, work in its favor. A more favorable corporate tax regime, which is particularly supportive of manufacturing firms, should reinforce growth, alongside additional fiscal and monetary easing," it said.
The agency further said India's economic growth faces headwinds over the near term, including subdued private sector investment and sentiment, labour market difficulties, and soft demand conditions.
However, it believes the country's long-term outperformance will remain intact.
India's fiscal deficits will be higher in this fiscal year and the next, largely due to the economic slowdown and substantial cuts in corporate taxes, it added.
The Indian government's fiscal 2020-21 budget acknowledges a rise in the central government's deficit to 3.8 per cent in 2019-20, and expects the deficit to fall marginally to 3.5 per cent next year.
S&P said the general elections held in April-May 2019 returned a robust mandate for Prime Minister Narendra Modi's BJP-led government.
"The results suggest that major policy undertakings by the government in its first term, including GST and demonetisation, have not materially undermined support for the BJP-led coalition," it said.
Over the next one to two years, this electoral support could encourage the government to pursue further reform initiatives, especially those aimed at liberalising foreign investment.