By Ramesh Kanitkar
Finance minister Pranab Mukherjee is obviously right when he says there is no reason to panic about S&P lowering its outlook on India to negative from stable while keeping the rating at BBB- (S&P says there’s a 1-in-3 chance of a downgrade if things don’t get better).
The government has little external debt, forex flows don’t really depend upon country ratings and, as was pointed out by most analysts, there is little new economic news that S&P is reacting to. Indian fundamentals are stable, economic growth appears to be picking up, the current account deficit is largely the way it is due to excessive imports of gold and, despite the high fiscal deficit, RBI has ensured adequate liquidity and there are few signs of local investors being crowded out by higher government spend. And, as RBI governor Duvvuri Subbarao pointed out last week, not only is India’s import cover much higher than it was in 1991 (this was in response to the refrain that 2012 was the new 1991), forex reserves are around 95 per cent of external debt as compared to just 7 per cent in 1990-91.
But crises occur when concerns that can each be dismissed individually come together, the perfect storm as it were. India’s large forex reserves are a cushion, but with a 4 per cent current account deficit putting pressure on the rupee, any attempt by RBI to protect the rupee depletes reserves ($20 billion got spent doing this a few months ago). Gold import duties will curb growth and help reduce the current account deficit but, thanks to the GAAR issue, FII inflows fell from $9.2 billion in February to $1.7 billion in March and a mere $122 million in April. While FDI flows rose by $10 billion in FY12 (this matched, roughly, the decline in FII flows), this could get jeopardised by the retrospective tax changes and the near daily battle of words with Vodafone — the latest was the finance secretary saying Vodafone knew about the tax demand and even paid Hutch less due to this, implying it wasn’t quite the innocent it was making itself out to be (naturally, Vodafone has reacted sharply to this).
RBI has managed liquidity and ensured private investors weren’t crowded out, but this was due to lower private sector investments. The amount of restructured debts rose 500 per cent while the amount of loans approved at the corporate debt restructuring cell rose 35 per cent to Rs. 1.5 trillion by March 2012 and Crisil projects this to rise to Rs. 2 trillion by next March — while corporate default rates are up to a decadal high, Crisil points out this time around, it is not SMEs that are defaulting, it is large corporates.
Not panicking is sage advice, but only if followed with concrete action. The fact that, in the middle of all the bad tidings, the telecom regulator has given recommendations that seek to hike spectrum costs 10 times and to disrupt even the more profitable telcos kind of tells its own story. Forget reforms, the big fear now is that, in the run-up to the 2014 elections, the government could legislate the Right to Food which will add 1.5 percentage points to India’s ballooning fiscal deficit — a full-blown crisis with no one at the wheel is what S&P fears. So should we.
The other rating agency Moody’s forecast was a bit encouraging with projection that India is growing but below its potential as politics is weighing on the economy and termed the national government as the “single biggest drag” on business activity.
India’s outlook is still underachieving and poor management has dragged economic growth to below potential.
The single biggest factor weighing on the outlook is the Indian government. In all economies it is impossible to separate the economic from the political outlook, and that is particularly the case in India.
The report further noted that there is broad-based weakness in the economy as all sectors are vulnerable.
Softer global conditions, weak investor and business confidence, government paralysis, and tight monetary conditions are all weighing on demand. Almost all sectors have slowed, with particular weakness in manufacturing and mining, alongside a worrying contraction in private investment.
GDP growth slowed to 6.1 per cent year-on-year in the fourth quarter of 2011, the slowest pace since 2008, and is growing at around 6 per cent through the first half of 2012. However, a steady upturn in activity is likely to lift the second-half GDP growth to 6.5 per cent. This puts 2012 growth substantially below India’s potential of around 7.5 per cent.
Risks are still tilted to the downside because of the dire political situation, though there are some reasons for optimism. We see growth accelerating through 2012, but it won’t hit potential until the second half of 2013.
The report further said that the national government weighed down by corruption and funding scandals, has passed no notable bills. The government has lost all momentum, and progress is unlikely on existing bills like land reform, fuel subsidies, labour rights, and the much-discussed supermarket reforms between now and the next national election in 2014.
The report termed prime minister Manmohan Singh as an “ageing technocrat who now appears tired of the rough and tumble of Indian politics” and added that the UPA didn’t have the numbers or the leaders to push through tough-minded reforms needed to drive the next wave of growth.
Some of the other political risks include possible tensions with China, as highlighted by India’s recent missile launch, and Maoist insurgency spread across nine states.
However, the Reserve Bank of India’s bigger than expected 50 basis points interest rates cut in April is a positive move and it will lift demand from the second half of 2012. Besides, preliminary numbers indicating average monsoon rains in 2012 is another piece of good news. INAV