India's sovereign rating could be cut if the government loosens fiscal policy in the run-up to elections due by 2014 or sees a prolonged slowdown in economic growth, ratings agency Fitch said on Monday.
Both Fitch and Standard and Poor's earlier this year cut their ratings outlooks for Asia's third-largest economy to negative, putting the country in danger of being the first of the BRICS grouping of fast-growing economies to be downgraded to junk status.
Fitch said weak GDP data on Friday confirmed the slowdown in the economy, and recent reform proposals by the government, while potentially supportive of growth, would need time to work and face political risks in their implementation.
"Policy slippage and/or mounting evidence of a structural decline in the trend growth rate, such as protracted relatively weak economic data, could cause the ratings to be downgraded," its report said.
The Indian economy extended its long slump in the September quarter, growing only 5.3 percent, below the 5.5 percent expansion seen in the three months to June, keeping it on track for its worst year in a decade.
The ratings agency expects economic recovery to be shallow with real GDP falling to 6 percent in the current fiscal year from 6.5 percent in the previous year before recovering to 7 percent in the year that ends March 2014.
The agency, however, pointed out that the upbeat HSBC PMI reading earlier in the day suggests that growth may have troughed. India's manufacturing sector beat the expectations of economists to grow at its fastest pace in five months in November, boosted by strong export orders and a surge in output, a business survey showed on Monday.
"However, tight fiscal and monetary policy settings decrease the authorities' scope to support growth amid stubbornly high inflation and a commitment to consolidating public finances," the report said.
Fitch said several of the proposals announced by the government require legislative approval and policy reversals cannot be ruled out.
The government opened doors for foreign direct investment into sectors like multi-brand retail in mid-September but the parliament remains in deadlock, with no decisions reached since the start of the winter session on Nov. 22.
"The approach of general elections in 2014 means there is little time to fully enact reform. These risks are reflected in the Negative Outlook," Fitch added.
Fitch also pointed out that the government's five-year road map for reducing the fiscal deficit to 3 percent of GDP by 2016-17 is a stronger statement of intent than seen in some time, but added that India's track record of delivering on fiscal policy goals has not been encouraging.
"A loosening in fiscal policy ahead of the elections could further weaken India's public finances and put pressure on the ratings," it said.