In its latest report, Fitch Ratings said India’s external buffers appear to be sufficient to cushion the risks associated with the rapid tightening of monetary policy in the US and high global commodity prices.
“External finances are becoming less important in India’s credit profile, but we expect foreign exchange reserves to remain robust and India’s current account deficit to remain at sustainable levels,” Fitch Ratings said.
According to the rating agency, public finances are the main driver of the rating and are only slightly affected by these developments, mainly because India is relatively isolated from global volatility due to the state’s limited reliance on external financing.
India’s foreign reserves fell by nearly $101 billion in January-September 2022, but are still large at about $533 billion.
The decline has reversed much of the reserve accumulation that occurred during the Covid-19 pandemic and reflects valuation effects, a widening current account deficit and some intervention by the
According to Fitch Ratings, India’s forex reserve coverage remains strong with about 8.9 months of imports in September.
“This is higher than during the taper tantrum in 2013, when it was about 6.5 months, and allows authorities to use reserves to smooth out periods of external stress,” according to Fitch Ratings.
Large reserves also provide certainty about the capacity to repay debt. Short-term callable external debt corresponds to only about 24 percent of total reserves.
Gross external debt stood at 18.6 percent of gross domestic product (GDP) in 2Q22, which is low compared to the median of 72 percent for ‘
Government bond exposure is small, with only about four percent of GDP primarily in multilateral financing.
Foreign investors’ holdings of domestic sovereign debt represent less than two percent of the total, reducing the risk of spillovers to the broader market if they want to reduce their exposure, according to Fitch Ratings.
The rating agency predicted that India’s current account deficit will reach 3.4 percent of GDP in the fiscal year ending March 2023 (FY23), up from 1.2 percent in FY22.
The strong growth in domestic demand and high oil and coal prices led to a strong increase in imports. Meanwhile, export growth has slowed from the high pace of January-June 2022, amid price declines for steel, iron ore and agricultural commodities.
Recessions in key European and US export markets will weigh on short-term export prospects.
“However, we predict that the current account deficit will narrow to 2.0 percent of GDP in FY24, as an easing in global energy prices will also weigh on imports. Our robust medium-term economic growth outlook for India should allow financing of should facilitate the deficit, in particular of
According to Fitch Ratings, the increase in the current account deficit partly reflects a decline in household savings, which have risen significantly during the pandemic.
“Nevertheless, we expect India’s current account deficit to be larger in the coming years than in the pre-pandemic period. This is partly because we see budget deficits remain above pre-pandemic levels, with only gradual consolidation , amid increased public capex spending,” according to Fitch Ratings.
According to the rating agency, the RBI will continue to use reserves to manage exchange rate volatility and this is likely to further erode reserve buffers in the near term, but the impact will depend on the size and duration of the intervention.
Domestic factors are the main driver of the RBI’s current monetary policy tightening.
“However, the risks to our current forecast that India’s repo rate will peak at 6 percent in FY24 are on the upside as there is a significant chance of US rate hikes beyond our assumptions, adding further downward pressure could exert itself on the rupee and increase import price inflation,” according to Fitch Ratings.
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