Fitch’s Jeremy Zook Explains Why India’s Public Finances Remain a Weak Spot

India’s biggest fiscal vulnerability stems from the government’s high interest burden, a direct consequence of elevated debt levels. Interest payments alone absorb nearly 25% of the government’s revenue, more than twice the median for countries with a BBB credit rating, according to Jeremy Zook, Director of Asia Sovereign Ratings at Fitch Ratings.

“This significantly limits fiscal flexibility by constraining the government’s ability to spend on other priorities,” Zook told Outlook Business in an interview.

Fitch Ratings, one of the big three global credit rating agencies, has chosen to hold India’s sovereign rating at BBB- in its latest assessment. The agency notes the country’s robust growth prospects and solid external finances, but flagged the government’s weak fiscal position as a persistent “credit weakness.”

By contrast, Standard & Poor’s (S&P) Global Ratings took a more optimistic view. For the first time in 18 years, citing fiscal discipline and strong growth, S&P upgraded India’s sovereign credit profile—raising the long-term rating from BBB- to BBB and the short-term rating from A-3 to A-2, both with a stable outlook.

India’s fiscal deficit has narrowed sharply, from a record 9.2% during the Covid year to 4.8%. Analysts at S&P note that this adjustment has been achieved while maintaining strong growth, with real GDP expanding at an average of 8.8% between fiscal 2022 and fiscal 2024, the fastest pace in the Asia-Pacific region.

Fitch, on the other hand, last upgraded India’s rating from BB+ to BBB- with a stable outlook back on August 1, 2006.

The Investment Gap

While Fitch’s Zook acknowledges that India has managed to sustain strong growth alongside low inflation and gradual fiscal consolidation, he points to structural weaknesses that continue to weigh on the economy.

One is the lack of private-sector capital investment, which has left the government shouldering much of the burden on capital spending. “There are some uncertainties over the medium term, particularly as we have not yet seen a meaningful acceleration in private capex (capital expenditure), despite relatively healthy corporate and bank balance sheets,” says Zook.

In this year’s Budget, the Centre earmarked ₹11.21 lakh crore, equivalent to 3.1% of GDP, for capital expenditure. Over the past decade, budgetary spending on capital expenditure has risen nearly sixfold, even as private investment has remained weak despite corporate profits nearly quadrupling in recent years. Economists have repeatedly cautioned that India’s growth is being driven primarily by public expenditure, a trend they view with concern.

To spur private sector investment, the government this year announced significant tax relief measures. The income tax exemption limit was raised from ₹7 lakh to ₹12 lakh per annum, while the Goods and Services Tax (GST) structure was simplified by reducing the number of tax slabs from four to two and lowering rates on most items.

The rationale is that putting more money in the hands of consumers should stimulate demand, which in turn will offset the revenue impact. Fitch views the recent GST reform positively for GDP growth, but also cautions it to be slightly revenue-negative.

“We think there will be a modest impact on revenue from the GST changes, around 0.2% of GDP on an annual basis, and only about 0.1% in FY26,” says Zook. “This is a manageable hit, and we believe the government can absorb it while still meeting its fiscal deficit target of 4.4% of GDP for the year. While lower GST rates will support consumption, we expect the value effects from reduced rates to outweigh the volume effects from higher consumption.”

Short on Cash

The negative revenue impact of these tax cuts brings Zook to another, and perhaps bigger, weakness that is India’s elevated debt load. “Over the medium term, we forecast only a modest decline in the debt ratio, to around 78% of GDP by FY30 from about 81% now, even assuming nominal growth of 10.5%,” he adds.

Fitch’s reluctance to follow S&P in upgrading India’s credit rating has much to do with concerns over the country’s high debt and interest burden, which it believes, will continue to weigh on public finances. So far, India has managed to ramp up public capital spending while simultaneously reducing the fiscal deficit. But according to Zook, further consolidation will likely require some moderation in spending, highlighting the limitations of the government’s resources. Finance Ministry officials have also cautioned that, given the size of the Budget, capital expenditure should no longer be expected to rise at the steep pace seen in recent years.

Although India’s revenue-to-GDP ratio is not viewed as a weakness by Fitch, it is projected at 20.7%, below the 22.9% median for BBB peers. Zook suggests that revenue-enhancing reforms would strengthen India’s fiscal and credit profile. “Such reforms could improve the government’s ability to reduce the fiscal deficit further or enable greater allocation of resources toward capital expenditure and other long-term investment,” says Zook.

The key consideration for the rating going forward, he says, will be whether India’s strong growth outlook and its improving record on macroeconomic stability and fiscal credibility are sufficient to offset the structural weaknesses in its fiscal metrics.