Is the economy drifting towards a crisis?

April 30, 2012

(The views expressed in this column are the author’s own and do not represent those of Reuters)

Standard & Poor’s India outlook downgrade was expected. What is disturbing — the government managed to do that in less than two years. It was in March 2010 that India was upgraded to ‘stable’ — and now it’s down to ‘negative’. It was not because the government took a wrong step but because it did not take any step at all. And if this continues, the economy will be confronted with a crisis.

Ratings agencies are not taken seriously, more so by governments. Surely, ratings are not a precise science; it is more a matter of judgment. But no one likes being downgraded even when it is deserved. Last year when the U.S. was downgraded from AAA to AA-plus, U.S. officials called the assessment ‘hasty’.

In 2010, the Indian economy was growing at 8.4 percent. That growth also helped the exchequer to mop up more tax revenue and bring the fiscal deficit down to 4.7 percent, with public debt at 62.4 percent of GDP. The balance of payments was sound with current ratio at 2.9 percent which was fully covered by foreign investment and external commercial borrowings, leaving a surplus for the RBI to pile up foreign exchange reserves.

That excitement ended abruptly. By the last quarter of 2011, growth slumped to 6.1 percent. That was accompanied by a serious imbalance in the income and expenditure of the government and the country’s receipts and payments of foreign exchange.

Fiscal deficit in 2011-12 climbed to 5.9 percent, about a half of the increase in deficit having been caused by inflating petroleum subsidies. International oil prices had shot up but administered domestic petroleum prices were static. The government could not pass on the additional cost through higher prices to the consumer because it was resisted by political partners in the coalition government.

Possibly, the government would have increased prices had the UPA come out stronger in the Uttar Pradesh elections. But the results made the Congress lose political ground and the TMC could oppose with greater vehemence the suggested deregulation of diesel prices. The government consequently has to borrow 685 billion rupees to help people buy petrol and diesel cheap.

The greater threat, however, comes from balance of payments. Trade is hopelessly imbalanced with a $185 billion deficit in 2010-11, the highest so far which pushed the current account deficit to 4 percent, one percent above the danger mark. The rupee has depreciated, FII investment is on hold and short-term debt is high. Chances are that as in 2012, the RBI will have to draw down reserves signaling erosion in creditworthiness and outflow of investment.

S&P cannot be blamed if it reminds us that the economy is precariously poised. The government and the RBI know that well. But managing the economy is now more about managing the coalition. That is difficult because the different partners are not on the same wavelength. But keeping the partners amused, as has been done so far, will only invite a crisis.

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Standard & Poor’s has sent an early shot across India’s bow by downgrading its credit rating. Ironically, Moody’s had patted the country on the back as recently as last December. Undoubtedly, India needs to get its act together and improve its financial status. But what is disturbing is rating agencies’ hubris and often suspicious ways in which a nation’s performance is rated. Besides, rivalry between ratings agencies is frequently brought to the fore. It’s time such ambiguous ratings are disregarded in favour of disinterested observations.

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