Despite slower GDP, high fiscal & current account deficits, India is faring better than major economies
In the aftermath of the financial and sovereign debt crises there has been a tendency for global rating agencies to follow a conservative path to credit rating. Such an approach has had its own share of controversies, especially when the US was downgraded. Some aver that rating agencies are playing safe by downgrading countries to hedge against possible default. The fact that new countries are getting on-stage to enact a crisis has made it challenging for the rating agencies.
India has been under the scanner for some time now with each and every action being watched closely. As the rating will come up for review, the apprehension is palpable. The view here is that we are past the ‘worst’ and, therefore, there is little reason to alter India’s credit rating as the economy does exhibit some strong proclivities and, more importantly, our policy stance has shown character in the last 6-8 months. Intuitively, if the rating was not altered last year, there is no reason for the same today as things have only improved in most areas, albeit at a different pace.
First, while GDP growth has come down in FY13, it should be realised that the same has happened across the world. China has witnessed a decline of 1.7%, Korea 1.7%, Singapore 3.9% and Indonesia 0.3%. The fact that our GDP growth would be around 5%, notwithstanding stagnation in industry, indicates the resilience of the economy.
Second, inflation has been more due to structural factors than policy-induced measures. Core inflation has been less than 5% and the Reserve Bank of India (RBI) has followed an aggressive anti-inflationary stance throughout the year. Inflation has come down over the last three years and one reason why it remains high is partly on account of the revision in oil product prices to contain the subsidy bill—something which the rating agencies have been asking the government to do. Quite clearly, inflation should not be a worry for the CRAs.
Third, the fiscal deficit has been contained at both the Centre and state levels, which is commendable, even though it has been at the cost of cutting down on project expenditure. More importantly, the subsidy bill has been controlled through revision of fuel-related products prices. Besides, fiscal deficits are very high in the developing world—the US (5.4%), Japan (9%) and the UK (7.8%). More importantly, the debt-to-GDP ratio is much lower for India compared with the US (101%), the UK (89%), Japan (211%), France (90%) and Italy (127%). Importantly, at around 50% of GDP, total liabilities of the government are largely held by domestic institutions (just 1% is held by FIIs) and hence does not pose any risk to the outside world.
Fourth, while the current account deficit (CAD) has increased, a lot may be attributed to the global slowdown where exports, software receipts and remittances have come down. Imports too have slowed down, but as oil, coal and gold imports were high, the trade balance has increased. What has the government done here? First, it has increased the duty on gold to lower imports. Second, unlike in the past when a high CAD signified a crisis-like situation, what has become important is what the government does in terms of policy framework to get in capital inflows. This is where the government and RBI have been proactive in attracting FII and FDI investment. The fact that around $25-30 billion has come in the form of FDI and FII flows bears testimony to the faith reposed by foreign investors in the Indian economy. These investors are putting their money in markets, which are expected to grow. Hence, their revealed preference for India is evidence of their faith in the country.
Fifth, notwithstanding the chaos in the CAD, forex reserves have been stable at between $290-300 billion and the exchange rate range bound between R53-55/dollar. Besides foreign investment a lot of support has come from the ECB too where RBI has enhanced scope for companies looking to borrow from overseas market. Although the rising external debt is a concern, the debt service ratio at around 6% is quite bearable. Therefore, the pro-forex policies followed by the authorities have helped in stabilisation.
Sixth, the banking sector, though under some temporary strain due to rising NPAs, is very well capitalised. The fact that all banks are fully compliant with Basel II norms is encouraging. More importantly, credit is well dispersed and exposure to sensitive sectors is low. The rising NPAs and restructured assets could be taken to be more of a phenomenon that goes with the business cycle. The latter has been more in the sectors that have linkages with projects getting held up due to an impasse in resolution of certain Bills relating to, say, the environment or land.
Seventh, RBI has gradually started lowering interest rates keeping in mind the inflation levels, and the calibrated approach should be appreciated. Interest rates have been lowered by 100 bps last year, and the infusion of liquidity through CRR cuts and open market operations has addressed liquidity concerns. Such adept handling of liquidity has enabled RBI to manage the borrowing programme of the government without coming in the way of availability of funds for the private sector.
Eight, the government had announced a series of policy measures to resuscitate the economy since September 2012. While some issues remain unresolved, they should not come seriously in the way of development given that the government has shown urgency to clear several projects that have been held back on account of administrative reasons. Over 340 projects have been identified and the setting up of the Cabinet Committee on Investments (CCI) would help in expediting these projects.
Nine, the concern on the coming elections is another issue that has to be addressed. India has been working with coalition governments in the last decade, which has also been the time when growth has been fairly high. The formation of another such government should not really affect the direction of reforms, though admittedly the pace would vary. Therefore, political considerations should not come in the way of rating of the sovereign, as even in the past, the present opposition parties have gone along with reforms.
Hence, while the Indian economy is certainly attempting to make an exit from a low equilibrium trap, the structures that have been erected to bring about the turnaround need to be appreciated.
The author is chief economist, CARE Ratings. Views are personal