Fitch affirms Kerala rating at 'BB' with stable outlook

The agency has assessed the state's revenue robustness as 'stronger' and the standalone credit profile in 'BB' category, reflecting a combination of the mid-range risk profile. The state's gross regional product (GRP) rose 11.4 per cent in FY19 at current prices to Rs 7.8 lakh crore, which is compound annual growth rate (CAGR) of 10.4 per cent in the immediate past four years (FY15-FY19).

Rating agency Fitch on Wednesday affirmed its rating for Kerala at 'BB' with a stable outlook. The BB rating is for the long-term foreign currency and local currency issuer default ratings of the state, the agency said in a statement.

"The BB rating affirmation with stable outlook" is based on a 'mid-range' assessment of the state's risk profile and a moderate 'bbb' debt-sustainability assessment, Fitch said, adding that Kerala is a 'type A' government as it can incur structural deficits. The agency has assessed the state's revenue robustness as 'stronger' and the standalone credit profile in 'BB' category, reflecting a combination of the mid-range risk profile.

The state's gross regional product (GRP) rose 11.4 per cent in FY19 at current prices to Rs 7.8 lakh crore, which is compound annual growth rate (CAGR) of 10.4 per cent in the immediate past four years (FY15-FY19). "We estimate FY20 GRP at Rs 8.7 lakh crore. Kerala's total revenue increased at a four-year (FY15-FY19) CAGR of 12.5 per cent, faster than its GRP," it said.

The state has stable revenue sources, as its tax and non-tax revenue accounted for 67 per cent of operating revenue in FY19, higher than the all-state average of 55 per cent. Tax composition is goods and services tax at 41 per cent, sales tax and value-added tax at 38 per cent, vehicle tax at 7 per cent, and stamp duty and registrations at 7 per cent, Fitch said.

"We expect GST to stabilise, which will augment the state's revenue capacity as the tax base expands with greater efficacy. GST compensation, which is the transfer from the Centre to cover potential losses in tax revenue, will also smooth state finances," the agency added. As much as 63 per cent of the FY19 transfer comprised centrally collected taxes such as corporate and income tax, it noted.

The Fourteenth Finance Commission increased the states' share in Central taxes to 42 per cent for FY15-FY20, from 32 per cent, the biggest increase in decades. The lockdowns following the pandemic have damaged the state's economic and fiscal performance, with tax and non-tax revenue dropping in FY21, Fitch said, adding that it expects a recovery to start in FY22.

Kerala's FY20 budget increased tax on new motorcycles, cars and private-service vehicles by 1 per cent and tax on sale of foreign liquor by 2 per cent. Kerala shares around 2.5 per cent of all Central taxes, based on a formula that is tied to India's overall economic and fiscal growth momentum, it said.

Kerala has been leading other states in demographic and human development indicators relating to health, education, and gender equality. Total expenditure rose at a FY15-FY19 CAGR of 11.8 per cent, in line with the 12.5 per cent CAGR of total revenue growth, showing robust control over expenditure, Fitch said.

Capex only accounted for 8 per cent of total expenditure in FY19, despite a faster 18.2 per cent FY15-FY19 CAGR against operating expenditure growth of 10.2 per cent, as the state intends to boost infrastructure development, it added. Kerala's committed expenditure, including on salaries, interest and pensions, amounted to 61 per cent of the total in FY19. The state also plans to cut expenditure to meet fiscal deficit goals in the next few years by reducing employees and limiting salary growth.

The maturity of Kerala's outstanding loans is well-dispersed, with over 60 per cent of debt due after five years. The agency forecasts Kerala's economic-liability burden, the primary metric of debt sustainability as measured by net overall risk plus the pro rata share of Central debt/regional GDP to remain within 70-90 per cent until FY24, leading to an 'a' debt-sustainability assessment.

It, however, lowered this to 'bbb' due to weak secondary metrics, ranging from a negative payback ratio to a fiscal debt burden of over 250 per cent. The agency said the rating and outlook may be upgraded if there is an improvement of the economic-liability burden ratio to below 70 per cent as against 72 per cent in FY19 and a substantial improvement in the fiscal-debt burden and payback ratio.

However, a deterioration of the economic-liability ratio above 100 per cent and a substantial worsening in the fiscal-debt burden and payback ratio could lead to a downgrade, it added..