The threat of a junk rating

May 20, 2013

(Any opinions expressed here are those of the author and not of Thomson Reuters)

Credit ratings by agencies are never very objective and their long-term outlook is also seldom accurate. Sovereign ratings, in particular those which are not solicited, are generally unreliable and often biased. But rating agencies do draw attention to critical issues that should not be ignored.

Standard & Poor’s announced on Friday that it had maintained India’s rating at BBB- with a long-term negative outlook. This assessment is based on three major considerations. The budget deficit, government debt and the current account deficit (CAD) are too high.

The fiscal deficit has been at the centre of debate and action for more than six months and the finance minister has brought it down from 5.7 percent last year to 4.8 percent in 2013-14 with the assurance that it will be brought down further. But there are still doubts.

Debt is not yet a big problem for India though it has its ramifications. Going by the IMF, government debt in Japan is 236 percent of GDP, 107 percent in the United States and 88 percent in the United Kingdom. For India, it is 67 percent with a foreign debt component at 4.7 per cent of GDP. Debt has a cost. In the current year, for example, interest payments by the central government would be 3.7 trillion rupees, which would be 22 percent of the total expenditure or two-thirds of the budget deficit.

If used productively, debt pays for itself. But that has not been the case. Less than a quarter of interest payments have been recovered from interest receipts and dividends. Debt is not the issue – its use is.

The CAD is still a problem though it is lower this year. The main cause is the trade deficit which crossed $17 billion last April. Partly, because exports have been sluggish, partly because imports have been excessive – particularly of unproductive assets like gold.

There has been some improvement in the two problem areas – budget deficit and external payments deficit. The finance minister is also committed to a measured cut in these deficits over the next three years. But it is possible that performance may fall short of targets. To bridge this gap S&P would like the government to complete the reforms it has initiated. The land acquisition bill and the Goods and Services Tax have been identified as important. The opposition hardly realizes that by blocking these reforms in parliament, it is blocking the development of the economy.

S&P is not without patience. It will watch India’s progress for another year before it makes the next assessment, although it is already negatively charged. That is what has led it to conclude that the chances of India’s sovereign rating being downgraded are one in three. Surely, the government wants to resolve the problems. The agency should also recognize that there are improvements which signal a better future.

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