Higher government deficits and higher debt stock over an extended period is the key risk to India’s investment grade credit rating, Andrew Wood, director Asia-Pacific Sovereign Ratings at S&P Global Ratings, warned on Wednesday.

S&P currently has India at “BBB-“, its lowest investment grade rating, with a stable outlook.

“We will be watching the balance between the economy and the fiscal settings in India very closely going forward because in our opinion higher growth rates over the next few years are going to be critical to contain, maintain and finance the government’s higher fiscal deficits and debt stock,” Wood said during a webinar.

He said there are signs of stabilisation in the economy especially over the last four to five months and S&P is seeing a good potential for India to “somewhat rebound” in the fiscal year starting April.

However, he emphasised that maintaining the high nominal and real growth will be key

India has exceeded its fiscal deficit target of 3.5 per cent in the current fiscal by a wide margin due to higher spendings to stimulate economy amid the pandemic. The fiscal deficit – the excess of government expenditure over its revenues – has been pegged at 9.5 per cent of the gross domestic product (GDP) in the current fiscal ending March 31, as per the revised estimate. For the next 2021-22 fiscal, the deficit has been put at 6.8 per cent of the GDP, which will be further lowered to 4.5 per cent by 2025-26 fiscal ending March 31, 2026.

''Vast economic growth is crucial and critical for maintaining those deficits at those rates financing them and keeping debt stocks from rising even further. If that were to the case if the economy were to recover at a much lower pace than expected we would have additional concerns regarding the sustainability of those fiscal accounts,'' Wood added.

Wood said with growth rebounding by 10% in the next fiscal year will only take India to GDP levels seen in FY20 and would mean a permanent loss of 10% of production as compared to the pre-pandemic path that the economy was on.

Any premature withdrawal of the fiscal support by other economies globally which are seeing nascent recoveries could also have knock-on impact on India, he added.

“The government’s more aggressive fiscal stance as presented at the budget earlier this month should be supportive of the recovery,” he said.

India set a fiscal deficit target of 6.8% of GDP for the year ending March 2022 and said it aims to bring down the fiscal deficit to 4.5% of GDP by 2025/26.

“It will be critical for economy to maintain a relatively high growth to ensure fiscal deficits don’t stay in double digit territory for an extended period of time. If that happens we will begin to have more concerns,” Wood said.

S&P is also closely monitoring the country’s vaccination drive to see how the government manages to inoculate at least a vast majority of the 1.4 billion population by the end of 2022.

Among risks to the economy, Wood said a second and larger wave of infections in India can pose a significant risk, as it has in other global economies, while inflation also needs to be watched as it could prompt the central bank to hike rates a bit more quickly and sooner than expected.

He said India will be one of the fastest growing emerging market economies with a 10 per cent growth in the next fiscal,

'India will be one of the fastest growing economy in the EM (emerging market) space. India's contraction this year was steep and may be deeper than global average, but bounce back of 10 per cent that we are expecting next fiscal year will be putting India amongst the fastest growers in 2021 and more importantly we see Indian economy growing at 6 per cent over medium term, may be slightly higher, and that compares very well to EM all around the world,'' Wood said in a webinar on India outlook for 2021.

Wood said the forecast for India in 2021 is on stronger side and shows that a lot of economic activity, which was frozen last year, is coming back on line to normalisation thereby brightening the growth prospects, as well as structural strengths of Indian economy coming back to the fore.'S&P said India's economy has stabilised over recent months, with progressively better manufacturing, services, labour market, and revenue data. The hard part will be converting these trends into a sustained recovery over the next few years.

S&P Associate Director, Financial Institutions Ratings, Deepali Seth-Chhabria said the presence of large number of government-owned banks distort the competitive environment in Indian banking sector. Government's announcement to privatise two public sector banks is a welcome step and this process would require legislative changes to lower government stake in PSBs below 51 per cent. '

'In long term it (privatisation) would improve system efficiency. In terms of consolidation, yes Indian banking system is a fragmented market and we do see the logic for consolidation … We always believe consolidation is not an answer to the NPL and the capital issue that banks have been facing. Consolidation has to be accompanied with improvement in risk management and branch and staff re-alignment and governance improvement,'' she added.

In 2021-22 Budget, Finance Minister Nirmala Sitharaman announced that the government would privatise two public sector banks and one general insurance company.