June 11, 2012

India Could get Junk Credit Rating

Credit rating agency Standard and Poor's has warned that India may become the first among the BRIC - Brazil, Russia, India and China - countries to lose its investment grade rating, citing slowing GDP growth and political roadblocks to economic policy making as some of the factors that could lead to such an action.

Standard & Poor's raised India's long-term sovereign credit rating to 'BBB-' in January 2007, making India the poorest sovereign (in terms of per capita GDP) to receive an investment-grade rating. One of the key elements contributing to the upgrade, and sustaining the current rating, was India's ability to achieve comparatively high rates of economic growth. Favorable long-term growth prospects and a high level of foreign exchange reserves support the country's sovereign rating, while large fiscal deficits, a high debt burden, and a lower-middle-income economy constrain it.

India's economy expanded roughly 8%-9% in the three years before the recent global financial crisis. According to data from India's Planning Commission, rapid growth contributed to a decline in the poverty rate to 29.8% in 2010 from 37.2% in 2005, implying a drop of 40 million people in the absolute number of the country's poor. Per capita income doubled during those five years. In addition, the total fertility rate (the average number of children a woman conceives) fell to 2.5 in 2010 from 3.2 in 2000.

India's GDP growth in the most recent quarter was 5.3%.


GDP is expected to grow about 6.5% in fiscal year 2012-2013, similar to the rate in fiscal 2011-2012. Both savings and investment rates (as a share of GDP) rose impressively, in step with GDP growth, until fiscal 2007-2008, before declining modestly in subsequent years (see chart 2). The public sector savings rate has historically been low, but itrose to 5% of GDP in fiscal 2007-2008 as the government narrowed its fiscal deficit, before dropping precipitously in recent years.The combination of fiscal strain and lower corporate profitability could reduce both public and private sector savings rates in coming years. Lower savings would translate into lower investment and a higher current account deficit. The result would be either lower GDP growth or a higher external deficit that makes the country more vulnerable to external shocks.

S&P-Report-Will India Be the First BRIC Fallen Angel_June2012




The Government's Response To Possible Scenarios Will Influence India's Credit Quality

The political context (and not lack of willingness among key economic policymakers in the central government and the central bank) may limit the government's ability to act decisively and quickly to manage an eroding economic environment and possible external shocks.Under one possible scenario, the government could take modest steps to contain the growth in spending in fiscal2012-13, especially on subsidies. GDP growth could remain close to official projections (exceeding 7%), perhaps sustained by the central bank's recent interest rate cuts. The government could make modest progress in reducing its structural fiscal deficit and with pushing through some reforms and administrative measures that encourage investment and reverse the recent drop in confidence in the private sector (both local and external). Moderating oil prices could reduce the current account deficit and stabilize the recent erosion in India's external position. We would likely maintain the sovereign credit rating at its current level under such a scenario.Under a more pessimistic scenario, political problems could prevent the government from containing the growth in current spending, and lower-than-projected GDP growth could result in revenue shortfalls. Politically inspired spending programs could further widen the fiscal deficit. Lack of progress in alleviating bottlenecks in key sectors of the economy could lower both domestic and foreign investment levels. Fiscal slippage, combined with persistently high inflation, could further weaken investor confidence. Both the government's debt burden and fiscal flexibility could continue to erode, in step with rising external vulnerability because of higher trade and current account deficits. India's credit quality would suffer under such a scenario, and a downgrade could result.


The Country Is Better Positioned To Weather Setbacks Than In The Past
Despite its recent problems, the Indian economy remains in much better shape to muddle through the current period of heightened global uncertainty than it was earlier, especially in the early 1990s, when it suffered a balance-of-payments crisis. The risk to external liquidity is much lower, thanks to more than $250 billion in foreign exchange reserves and a floating exchange rate that gives scope for adjusting to external shocks.

India's financial markets are also deeper and more sophisticated than before.Moreover, the dynamism unleashed by years of gradual economic liberalization has strengthened the country's productive base and created a momentum of its own. Many Indian firms have become globally competitive, both in manufacturing and in services. India's exports continue to grow as a share of total world exports. The recent improvement in the country's physical infrastructure, especially its roads and highways, will continue to spark new economic activity in coming years

In addition, the recent years of unprecedented prosperity have created a growing middle class, a stronger private sector, and rising aspirations among the general population. The growing political clout of those political constituencies that stand to benefit from more economic reform augurs well for the direction of long-term economic policy.India's next national elections will take place by May 2014. From a political angle, the time-frame for significant economic reform is likely to be limited to the rest of 2012 and at best early 2013, before the election campaign takes priority. The central government is likely to advance during that period with introducing a new direct tax code and take steps toward gaining consensus for the proposed goods and services tax (GST) among the states. The last central government budget eased the path toward the GST by expanding the tax net to include a wider array of services. The government is scheduled to set up the technical platform later this year for administering and collecting the GST. The tax might not go into effect before the next national elections, but it is likely to happen eventually,given the heavy commitments the leading political parties and state governments of all political stripes have made.The government took steps recently to loosen rules for portfolio investment in the Indian market, indicating its desire to sustain external inflows. It may take similar modest steps to encourage FDI as well, helping sustain external funding.

Global Perceptions Of India Are Changing
Some observers in India possibly assume that the economy could sustain 6%-7% GDP growth in the coming years without active reforms or more effective economic management. However, we should not exclude the possibility of a more significant drop in trend GDP growth (perhaps to 4%-5%) if weak economic management coincides with a bad external shock or with bad luck, such as a poor monsoon. Under such a remote scenario, India would face the risk of stagflation if the authorities fail to coordinate fiscal and monetary policies and act decisively. Prolonged policy incoherence resulting from a poorly managed coalition government raises the risk of a tardy response, and a rating downgrade.

The strictly economic impact of a downgrade might be limited. India's domestic financial system can easily fund the government's commercial debt, which is denominated in local currency. However, a potential downgrade could have wider implications for the country.Global perceptions of India have changed remarkably in the past decade. India evolved from a country that appeared destined to remain poor, backward, and weak to one on a path toward prosperity, modernity, and power.The impact of this shift in global perception, paired with the country's very real economic growth during the past decade, altered India's global economic, political, and strategic standing. It would be ironic if a government under the economist who spurred much of the liberalization of India's economy and helped unleash such gains were to preside over their potential erosion.

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