UPDATE 2-India's ratings under cloud as govt finances sour

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MUMBAI, July 15 (Reuters) - India’s investment grade credit rating looked under threat after Fitch Ratings cut its local currency grade outlook to negative on Tuesday, citing deteriorating public finances, mainly due to subsidies.

Fitch’s warning followed comments last week from Standard and Poor’s cautioning Asia’s third-largest economy over rising inflation and widening current account and fiscal deficits, and it sent the 10-year bond yield 7 basis points up to 9.47 percent.

India made rapid strides in setting its fiscal house in order over the past few years, prompting Fitch, Moody’s and S&P to assign its foreign currency debt the lowest rating in investment grade.

But rising subsidies to offset costlier oil and food, interest payments and a possible hike in government wages are expected to make it miss this year’s fiscal target by a wide margin.

“Future actions with respect to India’s local currency rating will depend largely on whether the FY09 fiscal slippage is reversed, which would allow for a resumption of the decline in India’s high government debt ratios,” said James McCormack, Fitch’s head of Asia sovereign ratings.

Fitch maintained India’s BBB-minus rating for both local and foreign currency debt and kept the outlook on the country’s foreign currency rating stable.

Ratings agencies’ alarm over worsening government finances comes amid double-digit inflation and prospects of political uncertainty as parliament convenes on July 21-22 for a confidence vote in which the government will have to prove its majority.

Communist parties, who had lent the ruling coalition parliamentary support for four years, ended their backing last week in protest over a nuclear energy deal with the United States.


Moody’s still rates India’s local currency debt as speculative.

Analysts said Fitch’s revised outlook could make offshore borrowing by Indian companies more expensive.

"Their ability to raise capital abroad is compromised," said Abheek Barua, chief economist at HDFC Bank HDBK.BO.

“If the situation was more normal, I would have dismissed this as a peripheral thing. In this kind of market this will have an impact,” he said.

The federal fiscal deficit dropped to 2.8 percent of gross domestic product in 2007/08 from 5.9 percent in 2002/03, thanks largely to buoyant tax revenues from blistering economic growth.

The economy has expanded by 9 percent or more in the past three years. The central bank estimates it to grow between 8.0-8.5 percent in the current fiscal year to March, above the estimates of many private sector economists.

But the gains made on the fiscal front seem to be fizzling out and annual wholesale price inflation was 11.89 percent at the end of June, its highest in the current index.

The government aims to contain the central fiscal deficit within 2.5 percent of GDP in 2008/09.

But Fitch said interest payments, civil servant wages and subsidy bonds issued to oil and fertiliser firms could push the shortfall to 6.5 percent of gross domestic product or beyond.

McCormack said in a statement Fitch’s change in outlook was partly due to a notable increase in government debt issuance to finance subsidies not reflected in the budget.

The rating agency expected the trade deficit to widen to 8.2 percent of GDP in 2008/09 from 7.7 percent in 2007/08, driven by high oil prices, but projected the current account deficit to hold at about 1.5 percent of GDP.

“Based on the change in global investor risk appetite and the less certain short-term macroeconomic outlook for India, Fitch believes capital inflows will decline sharply in FY09, but they are expected to be sufficient to finance the current account shortfall,” it said. (Editing by Charlotte Cooper)