Forget twin deficits, India has quadruplet deficits to worry about

Predictably, there was intense debate about what the Standard & Poor’s (S&P) recent step to lower the outlook on India’s long-term sovereign debt rating meant for the country and its economic fortunes. The general consensus is that it serves, at best, as a timely wake-up call for the government and policymakers, since much of what S&P flagged isn’t really new. The Reserve Bank of India and, indeed, the finance minister have been talking of the need for credible fiscal consolidation as the most important task if the fisc is to be fixed.

However, even if we choose to keep the S&P warnings aside, the government has enough to grapple with if the economy is to be brought back on track. Already, the latest purchasing managers’ index (PMI) print indicates that while the economy is still expanding, there are major input and output cost pressures, indicating that while the RBI did stick its neck out and cut the repo rate by a deep 50 basis points (something critics have frowned upon), there are risks associated with it since inflationary pressures are still intense. Clearly, RBI has put growth concerns above inflation this time round, and the results will have to be assessed in detail over the next few months.

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[caption id=“attachment_295949” align=“alignleft” width=“380” caption=“Citi India’s Rohini Malkani, in the group’s latest report on the economy, says the India story has likely de-rated if one takes these four deficits in conjunction. Reuters”]  [/caption]

However, experts and policywatchers are talking of not just the twin deficits - the current account deficit at around 4 percent of GDP and the fiscal deficit at 5.9 percent of GDP - but a ‘quadruplet’ deficit problem, adding the governance deficit and liquidity deficit to the list.

Citi India’s Rohini Malkani, in the group’s latest report on the economy, says the India story has likely de-rated if one takes these four deficits in conjunction. The self-inflicted governance deficit that the government is now grappling with - with policy paralysis being one of the most commonly used phrases in business circles - and a liquidity deficit that is cyclical but threatens to turn structural is threatening to compound the problem.

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Says Malkani: “There is no simple fix: the vicious deficit mix is feeding on and across itself. The solution lies in, first, an aggressive thrust on fiscal consolidation, policy and execution reform; and second, India needs a bit of luck on lower oil prices, weaker inflation and stronger capital flows. It needs a mix of both to regain its lustre - and at least one of the two to maintain its current momentum.”

Malkani’s report says the growth slowdown is bottoming, now clearly forecasting 6.5-7 percent growth, rather than the 8-8.5 percent average of 2000-10. On other macro variables, Citi’s forecasts for the financial year ending March 2013 (FY13) factor the current account deficit staying at 4 percent of GDP, the fiscal deficit at 8.4-8.8 percent of GDP (factoring in the Centre’s deficit at 5.5 percent, and including state electricity board losses), and inflation (WPI) averaging 7.4 percent in FY13 (estimated) versus 8.8 percent the previous year.

Growth expectations have been moderated even by RBI, which says in its policy statement of April that the trend rate of growth - the non-inflationary growth rate - has moderated from its pre-crisis peak.

While S&P had said that India’s high fiscal deficit and heavy debt burden remain the most significant constraints to its sovereign rating, the Citi analysis says the debt indicators are high, but provide some comfort.

India’s total debt works out to 136 percent of GDP, up from 113 percent in the early 1990s. That is due to a sharp rise in private debt from 30 percent of GDP earlier to 65 percent currently. Much of this is domestic private debt, reflecting an increase in bank credit/corporate debt. Public debt, on the other hand, has moderated from 78.8 percent in the early 1990s to 71 percent currently. “However, this has happened largely because of high nominal GDP growth and would break down if growth collapses and goes back to levels seen in the 70s,” Citi notes.

The growing fiscal deficit and, consequently, large government borrowings have also resulted in liquidity pressures. “Since June 2011, the liquidity deficit has increased beyond the RBI’s comfort zone of 1 percent of net demand and time liabilities (NDTL), touching a high of Rs 200 crore ($40 mn) in March 2012. While trends have eased somewhat to Rs120 crore ($23 mn) currently, the deficit remains out of the RBI’s stipulated range,” the report says.

But the biggest problem and the top priority would have to be the governance deficit. Experts, economists and policy watchers agree that the lack of decisiveness in policy and the shilly-shallying on key policy matters by a weakened UPA government are causing enormous economic damage. Add to that comments by key officials like Kaushik Basu that reforms will get a big push only after the 2014 general elections, and you have an economy in limbo.

The state elections results have further weakened the ruling Congress, there is little sign of big-ticket reforms and worse, there are signs that foreign investors are seriously concerned about the Union Budget 2012’s provisions on GAAR and retrospective taxation. Chances are, that the next Budget would be populist, coming as it does a year before the general elections. What impact that will have on the fisc is anybody’s guess.

“Policy uncertainty and the gaping governance deficit are issues that need to be resolved first and foremost - and would, in fact, be imperative for other macroparameters to be corrected,” says Malkani in her analysis.

Only a credible mix of policy initiatives, coupled with strong signals that the government values stability of policy, can undo some of the damage which it has suffered of late on the credibility front. Otherwise, India may well have to pare its growth estimates further. A vicious circle is staring the economy in the face.