Fitch Places India On Rtg Outlook Neg On Fiscal Concerns.

Business Editors

NEW YORK--(BUSINESS WIRE)--May 31, 2001

Fitch, the international rating agency, today changed the Rating Outlook on India's sovereign ratings from Stable to Negative citing well- flagged concerns about fiscal policy, privatization and the deterioration in the

Fitch currently rates the foreign and local currency obligations of India `BB+' and `BBB-` respectively.

The negative rating outlook reflects the slow progress of the government in implementing privatization and addressing the weaknesses in public finances. The fiscal-monetary policy mix in India remains unfavorable, resulting in relatively high real interest rates and crowding out of private sector investment. Until the authorities display a concerted willingness to address fiscal imbalances, India will remain locked in a stop-go cycle of growth and the sovereign could slip into a debt trap. The recent corruption scandal, involving the ruling Bhartiya Janata Party (BJP)-led coalition government, threatens to exacerbate these trends and further slow economic reform.

India's general government fiscal deficit at over 9% of GDP is among the highest in the realm of rated sovereigns. Persistently high fiscal deficits have led to a build-up of the general government's debt burden, estimated to be over 60% of GDP. In addition, the government (both central and state) has guarantees outstanding amounting to 9% of GDP. Fitch reiterates the point that such guarantees, issued to back mainly infrastructure projects, are contingent liabilities of the government. This has most recently been borne out in the case of Enron, where the U.S. power company has invoked a central government guarantee for payment arrears accumulated by the Maharashtra State Electricity Board.

On the revenue side, the tax base remains small, while the expenditure profile remains rigid due to the high level of interest payments, subsidies, personnel and defense costs. Interest payments comprise nearly 50% of revenues, leaving little to be spent on the much-needed infrastructure and social sectors. India's fiscal management is also questionable given the repeated slippage in its fiscal deficits in the past several years. Despite the weak state of public finances, Fitch is disappointed that the government is envisaging only a modest fiscal consolidation in 2001/02 and even this target could prove challenging, as growth and revenue projections seem optimistic. Although the budget contains some positive structural reform measures, the defense-related corruption scandal and state- elections next year could put pressure on the government to delay these initiatives.

The privatization program has also been dismal, with the government repeatedly failing to meet its targets. Vested interests, a lack of political consensus in the ruling coalition as well as a fear of selling the public sector's `crown jewels' cheaply has made this process painfully slow. Fitch believes that the privatization process needs to be accelerated to lighten the burden on public finances, improve the efficiency of public sector enterprises, attract greater foreign investment and instill investor confidence.

Fitch expresses additional concerns over the dispute between Enron, the country's largest foreign investor, and the government and worries that this may herald a broader deterioration in the foreign investment climate. Foreign direct investment remains extremely low in India (less than 1% of GDP). Nonetheless, it has played an important role in restoring India's international creditworthiness over the past decade and continues to have implications for the sovereign rating.

India's sovereign ratings continue to be supported by the country's unblemished debt service record, its favorable external debt burden and comparatively strong international liquidity position. However, continued fiscal profligacy and back peddling on privatization and other structural reforms could adversely affect sovereign creditworthiness, prompting a more severe rating action over time. On the other hand, the ratings could stabilize if the government implements a clearly defined strategy of fiscal consolidation and puts in place a coherent set of structural reforms. The passage of the Fiscal Responsibility Bill, continued buoyancy of exports, and a boost in FDI flows that underpin further strengthening of international liquidity position would also be viewed positively.