The outlook on the 'BB+' long-term local currency rating was revised to stable from negative. At the same time, all the ratings on India (foreign currency BB / Positive / B, local currency BB+ / Stable / B) were affirmed.

"The outlook revisions reflect India's improving external liquidity and better prospects for the government's debt burden to stabilise," said S&P's credit analyst Ping Chew, director in the Sovereign & International Public Finance Ratings Group. "In addition, India's robust foreign exchange reserves, which exceed 2,000 per cent of short-term debt, mitigate the risk of volatility in external confidence."

S&P also revised its outlook on the Export-Import Bank of India's 'BB' long-term foreign currency rating to positive from stable, while the outlook on the 'BB+' long-term local currency rating was revised to stable from negative.

The sovereign ratings on India are supported by the country's good economic prospects, with the gross domestic product (GDP) growth likely to trend over 6 per cent over the medium term. The service sector is dynamic, while the industrial sector is benefiting from gradual deregulation, trade liberalisation, and modest improvements in infrastructure.

"Good economic growth could contain the pressure on India's already weak public finances, provided tax reform continues," said Chew.

India's external debt and debt service burden is expected to fall due to strong export growth and non-debt foreign capital inflows, which should help offset the impact of rising imports given the surge in oil prices. India's total external debt is likely to fall below 100 per cent of current account receipts for the current fiscal year ending March 31, 2005, compared with over 200 per cent in fiscal 1993.

Nevertheless, the sovereign ratings on India remain constrained by high public debt and serious fiscal inflexibility. "The country's fiscal weakness is the worst among rated sovereigns, leaving it particularly vulnerable to economic cycles and any decline in growth rates," said Chew.

The consolidated debt of the central and state governments is expected to hover around 80 per cent of GDP in the current fiscal year. The combined central and state government deficits amount to 9 to 10 per cent of GDP, while interest payments are likely to consume one-third of general government revenue in the current fiscal year.

Furthermore, India's contingent liabilities are high. Government-guaranteed debt amounts to 10 to 11 per cent of 2004 GDP, and the government has a propensity to support financial institutions and loss-making state-owned enterprises, including the decrepit electricity sector.

According to S&P, although the central government has stepped up efforts to rein in its budget deficit, the pace of budgetary consolidation is likely to be slow. The government aims to adhere to the Fiscal Responsibility and Budget Management Act 2003, which targets a gradual reduction of the budget deficit. Nevertheless, the commitment is noteworthy coming from a generally left-leaning government, reflecting a bipartisan support for fiscal consolidation.