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India in ratings
rut
By Kunal Kumar Kundu
MUMBAI - The recently released report by
Moody's Investors Service, "India: 2005 Credit
Analysis", has retained India's foreign currency
rating at Baa3, which is investment grade, but has
put the domestic currency rating two notches below
at Ba2. While the outlook on the foreign currency
rating is stable, mainly supported by growing
foreign exchange reserves, lack of meaningful
fiscal consolidation has prompted the rating
agency to signal a negative outlook on the
domestic currency rating. Fitch Ratings, another
international rating agency, has expressed similar
sentiments. Last month, Fitch concluded that it
would not be able to upgrade India's sovereign
rating purely because of concerns over the fiscal
situation.
The reaction of credit rating
agencies such as Moody's and Fitch comes amidst
the government's poor performance on the fiscal
management front. Some find the sharp change in
Finance Minister P Chidambaram's stance on fiscal
responsibility within eight months disconcerting.
He now seems to have relaxed his position on the
pace of reduction of deficit. In the United
Progressive Alliance government's first budget in
July 2004, the finance minister projected that he
would get the revenue deficit down to 1.8% (of the
gross domestic product) for 2005-06. In this year's
budget, he projected a revenue deficit of 2.7% - a
full 90 basis points more than what he said just
eight months ago.
Moody's Investor
Services and Standard & Poor's were quick to
point out that the finance minister might have
missed the boat on fiscal consolidation. They said
he let go of an opportunity for faster fiscal
consolidation during a time of higher growth, a
process which may become infinitely more difficult
in a climate of slow growth.
In this
regard, the trend of revenue deficits (defined as
the difference between revenue income and revenue
expenditure) in India presents a gloomy picture.
Since the turn of the century, revenue deficit as
a percentage of fiscal deficit (sum of revenue and
capital deficits) has been increasing, and touched
an all-time high of 79.71% in 2003-04. This means
the government uses close to four-fifths of its
borrowings just to meet its own housekeeping
expenses, leaving very little for capital (or
productive) expenses.
While a conscious effort was
made during the previous budget to reduce this
to around 55%, the revised estimate shows that
the figure in all probability will cross 61%.
Thus, while the government promised to keep the
deficit down, its housekeeping expenses exceeded its
target by close to 12% - from Rs761.71 (US$17.5
billion) to Rs851.65 billion. The projected
revenue deficit for 2005-06 is Rs953.12 billion,
which is 2.7% of the gross domestic product (GDP)
estimate for the fiscal year. In absolute terms,
this represented an increase of close to 12%. If
the revenue deficit is to be contained to 1.8% of
GDP for 2005-06, it should have been Rs634.51
billion, or Rs317.77 billion less, virtually a
third lower than the target.
Chidambaram,
like his predecessors, has not been able to make
much headway on the expenditure management front.
Revenue expenditure, as projected in this year's
budget, is up by a whopping 15.66%, from
Rs3,860.69 billion in 2004-05 to Rs4,465.12 billion
for 2005-06. At the same time, capital expenditure
is down 43%, from Rs1,197.22 billion in 2004-05 to
Rs678.32 billion for 2005-06. Thus very little
capital formation is occurring in the country,
with most of the money going into meeting daily
expenses.
With too many commitments to
make and too little leeway to meet them, the
finance minister had to resort to the unthinkable
- he held in abeyance for the year his promise to
stick to his favorite FRBM (Fiscal Responsibility
and Budget Management) Act, which aims at reducing
the revenue deficit to zero by 2008-09. This shift
was not exactly the kind of thing that inspires
confidence among rating agencies.
As a
result, a lot - perhaps too much - has been left
to be done in 2006-07 to 2008-09 to achieve the
fiscal responsibility target. The revenue deficit
needs to be brought down from the expected 2.7%
for 2005-06 to nil in three years, or a 0.9%
reduction every year after next year. So the
revenue deficit needs to come down from Rs950
billion to zero in three years, or a reduction of
about Rs300 billion per year. It doesn't take a
rocket scientist, or an economist, to surmise that
this is practically impossible, especially
considering the past record. Revenue deficit in
absolute terms has fallen only three times in the
past 20 years, and only about Rs10 billion each
time.
Moody's said that it was struck by
the finance minister's failure to honor the FRBM
Act. "I think the problem is that no one believes
they will meet their targets. So, I think it would
have been a statement of their seriousness of
intent had they been able to stick to it," Kristin
Lindow, lead sovereign analyst for India and a
vice president of Moody's, told the media.
Furthermore, there is every possibility
that the final revenue deficit figure for 2005-06
could be more than the one budgeted for. As we saw
last year, there seems to be a chronic tendency to
overestimate the amount of tax that can actually
be collected. The estimate of the excise duty
shows how overboard the government can go where
revenue collection targets are concerned. For the
financial year 2004-05, despite the resurgence in
the manufacturing sector, estimated excise
collections were almost 8% lower than the budget
target.
"Surpassing the targets set by the
FRBM would have boosted investors' confidence
significantly as it would have reflected the
government's ability to pursue a more aggressive
front-loaded fiscal consolidation process," said
Shelly Shetty, Fitch's analyst on India. Shetty
said instead of doing that, the government used
the "excuse of greater transfer of resources to
states" to put on hold the deficit-reducing
provisions of the FRBM. "This does little to
improve credibility."
Kunal Kumar
Kundu is a senior economist with a leading
bilateral chamber of commerce in India. He has a
Masters in Economics from the University of
Calcutta.
(Copyright 2005 Asia Times
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