Rating Upgrade Around the Corner for India, Says Bank of America

A strong government, stable currency and signs of faster economic growth mean India is back in favour as an attractive investment destination. India's share markets are already booming with the benchmark Sensex and Nifty hitting a series of record highs over the past several months mainly on the back of nearly $14 billion investment by foreign investors year-to-date.

A likely ratings upgrade in the coming months will be an icing on the cake, but that might not be far away according to a Bank of America Merrill Lynch analysis. Global ratings agencies Standard & Poor's and Fitch had cut their outlook on India to negative in 2012, warning the country of a possible rating downgrade to "junk".

But, BoA economists Indranil Sen Gupta and Abhishek Gupta say the negative outlook could soon be upgraded because of the following reasons,

1) Rebound in growth: India's growth is bottoming out far higher than Brazil or Russia, the investment bank says. It expects growth to rebound to 7.5 per cent by 2018, while agreeing with Reserve Bank Governor Raghuram Rajan's analysis that economic growth could reach 6.5 per cent by next year. A recovery in the US, sharp fall in Brent crude prices, stability in the rupee and the Modi regime's reform push could aid economic recovery, the investment bank added.

2) Drivers of inflation are fading: BoA economists say inflation is peaking and expect CPI inflation to come off to 6 per cent in 2016 in line with the RBI's forecast. Normal rains, lower oil prices and a stable currency will help bring down inflation, the economists say.

3) Risks from twin deficits have proven to be overdone: High fiscal deficit, in simple terms a worsening of public finances, was one of the big reasons for India's ratings downgrade in April 2012. The downgrade forced former Finance Minister P Chidambaram to come out with aggressive targets to maintain fiscal discipline. Current Finance Minister Arun Jaitley has vowed to narrow India's fiscal deficit to 4.1 per cent of GDP. BoA says there are risks to Mr Jaitley's target because tax projections are ambitious and some expenditure from the previous fiscal year has been deferred to the current year. But, the government is likely to stick to its net borrowing target (nearly Rs 5 lakh crore), which is a positive, it adds. Besides, India has managed to narrow its current account deficit sharply, thanks to the steps (like raising duty on gold) taken by the previous UPA government and the RBI. The Modi government seems to be in no hurry to overturn the previous regime's measures as far as gold duty is concerned.

4) Stability in rupee: BoA expects the rupee to stabilise in the 58-62 per dollar range. It expects Governor Rajan will continue to buy dollars till forex reserves are adequate for an eight-month import cover. The forex reserve will help to guard against contagion, the investment bank says.

5) Interest rate cuts around the corner: Over the last three years, interest rates in India have continued to be at elevated levels leading corporates to postpone investment decisions. But, with inflation easing, the RBI is likely to start reducing interest rates from February 2015, BoA says. This will boost economic growth and productivity. BoA economists expect India to emerge as the second-largest emerging market after China by 2019.