In its annual credit analysis on India, Moody's Investors Service says that the Baa3 sovereign rating is supported by credit strengths which include a large, diverse economy, strong GDP growth as well as savings, and investment rates that exceed emerging market averages.
According to Moody's the rating is constrained by the credit challenges posed by India's poor social and physical infrastructure, high government deficit and debt ratios, recurrent inflationary pressures and an uncertain operating environment.
The report is an annual update to the markets and does not constitute a rating action. It summarizes India's sovereign credit profile according to the four broad factors that underpin Moody's Sovereign Bond Ratings Methodology: economic strength, institutional strength, government financial strength, and susceptibility to event risk.
India's rating is based on an assessment of moderate economic and institutional strength, low government financial strength and low susceptibility to event risk.
Moody's notes that although India's GDP growth remains above that of its rating peers, it has slowed from about 8.4% in FY 2010 and FY 2011 to 5.3% in the first half of 2012.
Persistent domestic inflation and wide fiscal deficits precluded domestic policy loosening to combat the global growth downturn over the last year. Starting in September 2012, the government has announced measures to spur infrastructure development, allow increased foreign investment, and rein in the fiscal deficit.
However, in Moody's view, given the delayed timing and still modest scope of these measures, growth may remain subdued in the near term amid continued domestic political uncertainty and a global slowdown.
India's fiscal position has long been a constraint on its rating. The government's annual deficits tend to be among the highest within the Baa range, and have proven relatively more vulnerable to growth downturns due to elastic revenues and rigid expenditures. Although absolute debt levels have risen steadily, the government's debt to GDP ratio has been declining over the last few years, partly due to higher inflation.
Moody's assessment of low government financial strength is based on its expectation that the government's debt and interest payment burden will remain high relative to its annual revenues over the medium term.
The stable outlook on India's rating is based on Moody's expectation that the economy's structural strengths - a high household savings rate and relatively competitive private sector - will ultimately raise the GDP growth rate from around 5.4% in FY 2013 to 6% or higher in FY 2014, with this higher growth improving fiscal and balance of payments metrics.
However, Moody's cautions that unanticipated domestic political turmoil, a further worsening in global growth and financial conditions, or a surge in food and other commodity prices could all affect the pace and timing of the recovery.