Mumbai: Global rating company Standard & Poor's Ratings Services has cautioned that India's credit rating may face a possible downgrade from its current `BBB-/Stable/A-3', especially after the implementation of the Sixth Pay Commission report.

Although the union budget for 2008-09 addresses a host of economic and social issues, the government may face a multitude of challenges in the coming months that could place pressure on this budget's fiscal-related targets, S&P said.

"The primary threat to India's fiscal consolidation efforts stems from the Sixth Pay Commission, which will make its recommendations by April 2008," S&P's credit analyst Sani Hamid said in a report.

"The budget was broadly in line with our expectations," Sani said, adding, "It is largely designed to address numerous issues such as the need to maintain the country's growth momentum, mitigate the impact of higher prices, and boost infrastructure and social spending. As expected, given the lead-up to the general election in early 2009, it also contains several populist measures, such as a debt waiver to small farmers."

The budget assumes an official fiscal year 2008-09 (ending 31 March 2009) central government fiscal deficit of GDP of 2.5 per cent, compared with 3.1 per cent in fiscal 2007-08. While this is better than the 3.0 per cent target set out under the Fiscal Responsibility and Budget Management (FRBM) Act 2003, the country faces a host of challenges to its fiscal outlook in the months ahead, it said.
 
"The primary threat to India's fiscal consolidation efforts stems from the Sixth Pay Commission, which will make its recommendations by April 2008," Sani said. "Recent fiscal gains, a cornerstone of the sovereign's improved creditworthiness, could not only come under threat but be severely reversed by this pay review," he pointed out.

"Other challenges come from potential expenditure overruns and a sharper-than-expected economic slowdown. The latter would directly affect revenue receipts that have been the mainstay of the country's fiscal consolidation. The economy grew at 8.7 per cent in fiscal 2007-08, from 9.4 per cent in the previous fiscal year. We expect the economy to grow 8.2-8.7 per cent in fiscal 2008-09 and 7.9-8.4 per cent in fiscal 2009-10," the report said.

The S&P report said India's official fiscal position is also deemed to be understated given expenditure subsidies relating to oil and food and fertilizers are accounted for off-balance sheet. Taking these into account, we estimate the general government deficit to be 6.7 per cent of GDP in fiscal year 2007-08.

"A sharp increase in commodity prices has seen such subsidy-related bond issuances rise sharply," Sani noted. "While these expenditures are presently outside the scope of the FRBM, it is encouraging that the budget speech acknowledges the understatement of the present fiscal deficit and the need to account for such liabilities."

The ratings on India reflect the country's strong economic prospects, solid external balance sheet, and deep capital market, which support a weak but improving fiscal position. The stable outlook balances India's strong external liquidity and growth prospects with its weak fiscal flexibility, and reflects our expectation that the country will continue with efforts to consolidate its fiscal position despite the numerous challenges it faces. A reversal of the fiscal consolidation process, in tandem with a deterioration in the country's balance of payments performance, could potentially put pressure on India's credit standing, the report said.