Despite rapid economic growth of 8.1 per cent in the first half of this fiscal, global credit rating agency Fitch has warned India's "weak public finances" will constrain higher growth in medium term.
"The euphoria over India's rapid economic growth has tended to push concerns about the country's public finances into the background, leading some to question whether they matter at all," Fitch sovereign team senior director Paul Rawkins said in a statement.
He said doubts were being raised whether India could sustain growth of 7-8 per cent as despite periodic attempts to instill greater fiscal discipline, general government deficits remained high at 8-10 per cent of GDP and the public sector continued to absorb the lion's share of household savings.
In a latest report, Fitch was of the view that changing household savings behaviour, coupled with rising private sector demand for investor funds, suggest that in absence of a fiscal correction higher growth in India was going to become increasingly dependent on external financing.
The international rating agency also forecast a current account deficit of 1.6 per cent of GDP for 2005-06 and noted that net capital inflows were running at 3 per cent of GDP.
However, Fitch felt that with over $140 billion in foreign exchange reserves India was probably better placed than ever before to ride out external shocks such as rise in oil prices.
It was hard to find another major emerging market with India's level of public debt that has not experienced a crisis of confidence in recent times, Fitch said.
The apparent immunity was attributed to the country's long track record of macro economic stability and a domestic bond market that allows the government to issue long-dated, fixed rate securities in local currency, the agency said.
"We do not believe that India's public debt dynamics are explosive. Nonetheless, the fact that the debt/GDP ratio has continued to edge up to over 85 per cent even as growth has accelerated to 7-8 per cent indicates that India is unlikely to simply outgrow its debt burden," Rawkins said.
The public finances do matter on two counts - first a prolonged slowdown in growth could translate in a steep and potentially unsustainable rise in the debt/GDP ratio and second, savings currently absorbed by the public sector could be employed much more effectively elsewhere in the economy, the report concluded.
Fitch also pointed out that India's weak public finances are due to populist expenditure commitments born out of coalition politics and a narrow tax base.
It further said that it was too early to say whether the Indian economy is capable of sustaining 'Chinese-style' rates of expansion.
"If incremental capital output ratios are any guide, the greater efficiency with which India allocates capital relative to China suggests that it could emulate the latter's growth rate, provided that government tackles fiscal consolidation more convincingly and extricates itself more aggressively from domestic capital markets," the agency said.
Fitch rates India at foreign and local currency issuer default 'BB+'.