Moody's Investors Service says that it expects Indian refiners' credit metrics to improve over the next 12 months, while upstream producers' credit profiles should remain stable on the back of continued strong cash flow generation.

''We expect total borrowings and interest cost for our rated downstream refiners in India to decline in tandem with the decrease in fuel subsidies in the country, which will improve their credit profiles,'' says Vikas Halan, a Moody's vice president and senior credit officer.

Both refiners - Indian Oil Corporation (IOC, Baa3 stable) and Bharat Petroleum Corporation (BPCL, Baa3 stable) - reported stronger normalised earnings (excluding the impact of foreign-exchange fluctuations and fuel subsidies) and margins for the April-June 2014 compared to a year ago. These results were also despite their reporting of lower refining margins, which were, at the same time, in line with the decline in regional gross refining margins for the quarter. IOC benefited from higher non-core income, while BPCL benefited from higher sales volumes.

''The results for state-owned downstream refiners IOC and BPCL for the April-June 2014 were also supported by a near full reimbursement of fuel subsidies by the Government of India (Baa3 stable), again in line with expectations'', says Halan.

However, although the refiners are nearly fully compensated for under-recoveries, the six-month delay between the realization of the under-recoveries and the government's reimbursement means that IOC and BPCL rely heavily on short-term borrowings to fund the under-recoveries in the interim. Furthermore, the government does not reimburse the interest incurred on these loans.

Moody's anticipates a full deregulation of diesel prices over the next few months as it expects the newly elected government will continue to support the Rs 0.4-Rs 0.5 a litre price hike that has been in place since early 2013.

''Any decision to increase the fuel subsidies in India or slow down the pace of fuel price deregulation will be credit negative for the refiners,'' adds Halan.

As of August 1, the under-recovery on diesel is at its all-time low of Rs 1.33 a litre.

In the upstream oil and gas segment, Moody's report states that India's Oil and Natural Gas Corporation (ONGC, LC: Baa1 stable; FC: Baa2 stable) and Oil India (OIL, Baa2 stable) reported stronger operating results for April - June 2014 on the back of the higher crude oil price environment. These high crude oil prices more than offset the impact of the fuel subsidy burden. ONGC and OIL reported EBITDA growth of 20.2% and 31.8% from a year ago.

''We expect the financial profiles of the two rated upstream companies - ONGC and OIL - will remain strong in fiscal year ending March 2015, despite debt-funded acquisitions in Mozambique and our expectation that their fuel subsidy burden will remain high. The credit metrics for both remain well positioned, given low leverage and our expectation that they will continue generating robust cash flows despite elevated fuel subsidy burdens'', adds Halan.