Thank you, S&P: Why the rating agency did us a favour

By Latha Venkatesh

The decision of Standard & Poor’s to lower the outlook on India’s rating to negative from stable will draw the customary criticism of double standards. I agree that rating agencies have not at all covered themselves with glory in their past conduct. They are the last to recognise economic problems and their assessment of countries can be notoriously uneven.

I think these are valid criticisms. But there are two points in their favour, One, no two countries are similar and hence any debate to prove unfair rating can sound unconvincing. Second, S&P by lowering their outlook, have raised the issue of India’s unsustainable current account deficit to the headlines, which I think is a welcome service.

[caption id=“attachment_289335” align=“alignleft” width=“380” caption=“By bringing CAD to the headlines, S&P will hopefully have triggered enough political will for Parliament to accept some tough decision. Reuters”] [/caption]

Unlike inflation, which can easily grab headlines and parliamentary attention, the current account deficit is an esoteric term for the aam aadmi. It makes for an unattractive headline in a general newspaper and is unlikely to be the first lead even in a business paper. Yet our current account deficit (CAD) is serious today, and almost as serious as in 1991, when we had to pawn gold because of an inability to pay interest on an IMF loan.

By bringing CAD to the headlines, S&P will hopefully have triggered enough political will for Parliament to accept some tough decision.

Comparing 2012 to 1991 may not be such an exaggeration. Let’s look at our current account numbers. The trade deficit for 2011-12 has come in at $185 billion. Those are the Directorate General of Foreign Trade’s (DGFT’s) numbers. The final numbers are usually a good $10 billion more as they will include defence and other imports directly made by the government.

So total trade deficit may well be $195 billion.

Of course, against this are our strengths: software exports and remittances by Indians living abroad. This, together with travel, dividend and other earnings are called the invisibles. The invisible inflows were $78 billion in the first nine months of 2011-12. Invisibles usually do a little better in the fourth quarter. But this time around the Infosys numbers indicate that software earnings may at best be stable. Remittances may have increased because of India’s higher interest rates. Still, even assuming a $30 billion inflow in the fourth quarter, the full year’s invisibles earnings will hit a maximum of $108 billion ( That would be a 25 percent growth over last year’s invisibles earnings of $85 billion).

Net-net: the current account deficit will be at least $87 billion, that is 4.5 percent of our $1.8 trillion economy!!!

This, Dear Sirs, is a crisis. It means we have to get $1.5 billion d every week of the year to bridge our external gap. The problem is compounded by the fact that we are clearly moving to a lower trajectory of growth. We often argue that at 7 percent we would still be the envy of the world. But an investor who came to India one year ago on hopes of seeing 8-9 percent growth will shy away as he hears of 7 percent while he may add to investments in countries which are moving from 0 percent to 1 percent GDP growth.

In this context, the Reserve Bank of India (RBI) is in a Catch 22 situation. Ideally, the deteriorating CAD is an indication that the currency in overvalued and hence must be allowed to depreciate. But a steady depreciation will scare away capital flows and could quickly lead to a run on the currency. There will also be some serious harm done to domestic balance-sheets of big companies who typically have forex loans. Their woes will further scare captial flows.

Let us try to project the external accounts in 2012-13 (FY13) from the data we have for FY12. In FY12, imports of petroleum, oil and lubricants rose by 46.9 percent to $155.6 billion; Imports of coal surged by 80.3 percent to $17.6 billion; gold and silver imports jumped by 44.4 percent to $61.5 billion. Which means in FY12, 48 percent, or $233 billion of the total import bill of $488 billion, made up by crude, gold and coal. Add to this, vegetable oil imports which grew by 47.5 percent to $9.7 billion; and fertiliser imports, which surged by 59 percent to $11 billion. Would I be right in assuming these are all largely price inelastic imports?

Now, in FY13, we are assuming 7.3 percent GDP growth, that’s 0.5 percentage points more than the 6.8 percent we may have done last year. With half a percentage point higher growth and higher average crude prices, we have to assume at least a 25 percent rise in the crude import bill. Assume a like increase in coal imports, and our import bill for these two itself will be $220 billion.

One can’t be sure if the higher tariffs on gold will work, but chances are with continuing high inflation, gold will remain an attractive investment. Assuming a modest 10 percent increase , we are looking at a price tag of of $68 billion. So coal, gold and crude, will be a $288 billion bill. Add to this $20-22 billion of fertilisers and vegetable oils, the same as in FY12, and we have a $ 310 billion import bill that has to be paid because these items face near inelastic demand.

Among our other imports in FY12, machinery increased by 27.7 percent to $35.4 billion. Imports of electronics goods grew by 23 percent to $32.7 billion; iron and steel imports increased by 15 percent to $11.9 billion; These should logically be higher if growth is better in FY13. Assuming rupee depreciation makes some of these grow slowly, even then a 10 percent rise in our import bill should be expected at the very least.

On the export front, while they surged 21 percent in FY12, there are two negatives in FY13. The world is growing more slowly, especially some of India’s key markets, including Europe and China. Also software, our largest exports, is beginning to look wobbly.

In sum, the chances of our current account deficit remaining at 4 percent of GDP in FY13 remain pretty high at this juncture. And as unravelling data in the months ahead make it obvious that the fiscal and current account deficits will be uglier, neither the rating agencies nor the markets will be forgiving. Tough times for the rupee seem inevitable. We will be lucky if it doesn’t trigger a crisis.

Hence, my contention is that S&P may have done us a service by highlighting the problems. One hopes the noise in the press and by the commentariat is loud enough to force parliament to accept sharply higher diesel prices. The thoughtless and unbridled subsidising of diesel has led to massive investments in diesel SUVs ( which are fuel guzzlers) and in the careless and inefficient use of diesel in industry, be it for gensets, tubewells or automobiles. Such reckless consumption is being paid for by all citizens through taxes, higher interest rates because of government borrowing and greater financial instability because of a weak rupee.

Former Finance Minister Yashwant Sinha said on national TV he won’t support a diesel price hike because the UPA didn’t support his hike in 2001. I hope S&P has raised the ante on the current account deficit enough to make politicians take more responsible decisions.