Successive Indian governments have had a notorious track record of living beyond their means and blowing up the budget. The current UPA government has, with its well-intentioned but unfunded welfare projects like NREGA and the proposed Food Security Bill, built on that legacy of fiscal profligacy. That problem only gets compounded when you have ministers with discernible conflict of interests actively running India's state-owned airline to the ground, and have them line up for bailouts.
Yet, despite the manifest deterioration in India's fiscal prudence and the mountain of debt that has piled up, sovereign ratings agency Moody's sees no immediate threat of a downgrade to India's sovereign rating. In fact, in an interview to Firstpost, Atsi Sheth, Lead Analyst for India at Moody's Investor Services' Sovereign Risk Group, says that India "has the potential to grow out of its debt - so long as the government does not steer too far away from the fiscal path."
In Europe, sovereign ratings agencies have drawn criticism for their having "found religion": governments say the rating agencies' hawkish downward revision of sovereign ratings of indebted countries is compounding the downward spiral. Yet, India's growth momentum and steady institutional framework, notes Sheth, means that she has a higher tolerance level for marginal fiscal slippages and cyclical dips in growth projections. Excerpts from the interview:
Moody's commentary on the Indian budget in March said that fiscal consolidation was on track. Has anything changed in that assessment - in the light of provisions needed for the Food Security Bill and the bailout of Air India?
At the structural level, we still believe fiscal intentions are on track. The Food Security Bill and equity infusion for Air India equity are certainly things that add to fiscal expenditure, but they were already incorporated into our view. We acknowledge that in a country like India, with a public sector that is in many cases inefficient, there will be need for fiscal bailouts, as is happening with Air India. We also know that given the poverty levels and inequality in India, social welfare policies will have priority. So we understand that they add to expenditure, but we still think that fiscal intentions over the longer term do point towards consolidation. We've seen some of this happen already at the State level. Over the past three to five years, States have been at the forefront of consolidation, and the Centre has not. But even at the Central level, the fiscal intention seems to be there, even if implementation isn't. What we said about the Budget is that as a statement of intention, unnecessary expenditures hadn't been added onto the Budget - and we still think that is the case, inspite of the Food Security Bill.
What kind of numbers are you budgeting for the Air India bailout? Would the need for a higher-than-budgeted bailout skew your calculations?
If the numbers that are being bandied about now turn out right, there could be fiscal slippage on the Central government's budget deficit targets. But that's been historically true in India: every time a downturn comes around, the fiscal slippages tend to increase. And right now the growth cycle has peaked, so you'll see some slippage from that. Add to that the expenditure that also comes along with a downturn, we do expect some slippage. But as a percentage of GDP, it would still be a decimal point slippage at this point.
Even if one concedes the welfare gains from the Food Security Bill, how much of a cause for worry-from a fiscal consolidation perspective-is the lack of expenditure discipline?
In India's case, historically the fiscal has always been the weakest link in the macroeconomic outlook - and for many legacy reasons. Some 25 percent of your revenue goes for interest payments. Whatever the policy changes you undertake now, that is a legacy you can't undo very quickly.
Aside from the legacy issues, are fiscal intentions on shakier ground? We've seen in the past few years at the Central government level that it's been very hard to reduce expenditure. At the same time, pressures to increase it have been hard to deny. From a ratings perspective, that is already incorporated into our outlook. We understand that this will always be the case for India - because of the legacy issues as well as the socio-political environment in which the government operates.
Does this mean this year's budget and next year's budget will not proceed towards a smooth decline? The answer is yes. I expect that this year's budget's fiscal deficit target will not be met. And depending on when the Food Security Bill is actually passed and implemented, it will have implications for future budgets as well. But it's hard at this point to give a quantitative response to that.
The government recently raised petroleum product prices, but cut back import duties. Net-net, does this have a negative impact on fiscal consolidation?
There was a cut in subsidy expenditure, accompanied by a cut in revenue from duty, but the net impact will depend on how consumption proceeds. In a country that's growing 7-8%, perhaps it won't have a dramatic impact on consumption, in which case there could be a modest negative impact on the fiscal. But from a structural perspective, the rationalisation of indirect taxes like duty is net positive for the long term. Here is an economy where, say 10 years ago, your taxes came from consumption - you were taxing the very people that you wanted to help. That is now shifting, and the gap between direct and indirect taxes is now not so high. From that perspective, it may actually be a positive.
The monsoon thus far has been deficient. How much of a worry is that? In any case, growth projections for 2011-12 are being revised downwards. How will this affect the macro fiscal debt-to-GDP numbers?
In India, from a ratings perspective, dips-in and of themselves-are not as much of a concern because we do anticipate them. We've kept our growth projections lower than consensus - between 7 and 8 percent this year and the next. It's not just the monsoon, it's also the interest rate cycle: the tightening commenced last year, and you usually see the impact over 12 to 18 months. You're going to see both these things come together. The investment cycle has already slowed down quite significantly.
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What happens globally matters as well. So there's a trifecta-global concerns, monsoon concerns plus India's own inflation and interest rate trajectory-that's going to affect growth this year and the next.
How will this affect the debt metrics? We are projecting that over the next two or three years, India will see a reduction in debt-to-GDP levels - even if fiscal deficit targets are missed, and even if growth is not 9 per cent plus but more in the 7-8 percent range. That's simply because of the arithmetic: with 12 percent plus nominal GDP growth, your fiscal deficit would have to be very, very large for your debt number to increase as a percentage of GDP.
What we would have liked to see is a rapid decline in the debt-to-GDP numbers; we're not going to see that this year and the next, both because of growth and fiscal slippage. But we see this as a cyclical dip. What we worry about more are structural additions to expenditure - of which the Food Security Bill is one.
Have you seen anything that warrants a review of your sovereign rating or outlook on India one way or another?
When we look at India relative to other countries in its (foreign currency) rating category- Baa3-India's fiscal is the weakest link, but it has many things going for it: a growth dynamic, the size and diversity of its economy, a fairly steady institutional framework. Whatever you may say of policy, there's a predictability about governments and elections. Taking all that into account, particularly the growth outlook, which even during a dip surpasses that of most other countries, we believe the Baa3 stable outlook is merited.
Ratings agencies have been proactive in revising ratings downwards in Europe, and have in fact drawn criticism for that. What accounts for your higher level of tolerance for India's debts and deficits?
One thing that does help India's fiscal metrics is that if you look at the debt-to-GDP numbers over the last 10 years, you can see how much growth has helped it. There's not been much fiscal consolidation at the Central level, so it's really growth that has helped. India has the potential to grow out of its debt - and so long as the government does not steer too far away from the fiscal path, growth will see it through.
India's debt-to-GDP numbers-in the high 60s-compare alright with countries in its ratings category. There are, of course, several countries that have much lower debt levels, but they also have lower growth momentum.
Since this is about betting on growth, what are the biggest downside risks to growth in India?
There are three. First, capital costs. In the last 10 years, some of the dramatic uptick in India's growth was because of domestic reforms, but it was also helped by lower capital costs, both within the country and outside. Over the next couple of years, domestic capital costs will rise; globally, the credit environment is not what it was five years ago. The next cycle may have less of a boost from global monetary policy than it did in the last few years.
Second, commodity prices are a concern. At the current prices levels, India's balance of payment and growth can probably absorb them; were they to shoot way beyond current levels, that would be a worry.
The third downside risk is of course the much-discussed infrastructure failings.
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Updated Date: Dec 20, 2014 05:12:07 IST