India's external buffers appear sufficient to cushion risks associated with rapid monetary policy tightening in the US and high global commodity prices, according to Fitch Ratings.
"External finances are becoming less of a strength in India's credit profile, but we expect foreign-exchange reserves to remain robust and India's current-account deficit to be contained at a sustainable level," the credit rating agency says.
"Public finances remain the key driver of the rating and are only modestly affected by these developments, particularly as India is relatively insulated from global volatility due to the sovereign’s limited reliance on external financing," it adds.
This comes at a time when India's foreign reserves fell by almost $101 billion in January-September 2022 to around $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 Reserve Bank of India (RBI) to support the Indian rupee’s exchange rate, says Fitch.
"Reserve cover remains strong at about 8.9 months of imports in September. This is higher than during the 'taper tantrum' in 2013, when it stood at about 6.5 months, and offers the authorities scope to utilise reserves to smooth periods of external stress," the ratings agency says. "Large reserves also provide reassurance about debt repayment capacity. Short-term external debt due is equivalent to only about 24% of total reserves."
India's gross external debt stood at 18.6% of GDP in the second quarter, which is low compared with the median of 72% for 'BBB' rated sovereigns in 2021, says Fitch. "Sovereign exposures are small, with only about 4% of GDP in primarily multilateral financing. Foreign investor holdings of domestic sovereign debt represent under 2% of the total, reducing risk of spillovers to the wider market should they seek to reduce their exposure," it adds.
The ratings agency forecasts India's current-account deficit in the fiscal year ending March 2023 to reach 3.4% of GDP, from 1.2% in FY22.
Imports have surged on strong domestic demand growth and high oil and coal prices. Meanwhile, export growth has moderated from the fast pace seen in January-June 2022, amid declines in prices for steel, iron ore and agricultural products.
"Recessions in key European and US export markets will weigh on near-term export prospects. However, we forecast the current-account deficit to narrow in FY24, to 2.0% of GDP, as easing global energy prices will also dampen imports. Our robust medium-term economic growth outlook on India should facilitate financing of the deficit, particularly from FDI," says Fitch.
The ratings firm further expects India's current-account deficit to be wider in the next few years than it was in the period prior to the pandemic.
It also expects the RBI to use reserves to manage exchange-rate volatility. "This will probably erode reserve buffers further in the near term, but the impact will depend on the scale and duration of intervention," says Fitch.