Credit rating agencies and India's public finances

Like many other countries, India has received several warnings from international credit rating agencies about its public finances. The global economic crisis that began with the financial crisis of 2008-09 has pushed several governments into precarious situations regarding the sustainability of their public finances. The last downgrade of India's sovereign debt did not have any significant impact on India's government bond yields. This goes to show that the grades assigned by credit rating agencies are not the only things that the bond market takes into account while determining the yields on government bonds and the ability of the government to borrow money. However, like in the case of Europe, credit ratings can serve as useful warnings about possible vulnerabilities in the public finances of a country.

Since credit rating agencies do not specify recommended yield ranges for government bonds, individual and institutional investors should conduct their own independent analysis about government bonds. This has been the case for several countries in recent months. The yield on Indian government bonds of different maturity lengths has been around 8% recently. While India does need to take measures regarding taxation, spending ( for example, the right mix of subsidies, the right timeframe of subsidies etc ), growth and development, the recent threat by Standard and Poors to downgrade India's sovereign debt to junk status seems wide off the mark as regards the reality of the Indian economic scene. The recent Kelkar Committee Report and the Indian government's willingness to act based on it are signs that the Indian government is serious about addressing the fiscal sustainability issue ( the details about how fiscal sustainability is brought about and the right mix of policies needed to balance the goals of fiscal sustainability and human welfare do need to be determined carefully by the right kinds of debates inside India ).

Credit rating agencies should be careful when analyzing countries like India where massive human development challenges still remain. Also, their stress on the term " reforms " when it comes to rating India's government debt may well be a sign of superficiality in their analysis of the Indian economy and the short-term and long-term fiscal sustainability of the Indian government. A lot of the " reform " measures announced by the Indian government like relaxing FDI requirements in retail and in insurance may be less crucial for fiscal sustainability than things like human capital development, equitable growth and the health of the infrastructure sector. One cannot expect changes in FDI rules alone to bring about sustainable growth when the country has massive challenges in the areas of aggregate demand, human welfare, human capital etc. These factors are not necessarily significant to the same extent for European economies. Therefore, the impact of laissez-faire economic policies on growth and fiscal sustainability can be expected to be different for India and the European countries. Excessive stress on these " reform " measures and negligence in the human resources area and the aggregate demand area can even lead to weakness in public finances.

India's tax revenue to GDP ratio is less than 15% due to several structural factors. India's slow pace of development in the rural sectors of the economy is a contributing factor in India's inability to raise more tax revenue. While many will agree that economic growth, understood broadly, will be a crucial factor for improving the government's ability to increase tax revenues, there is a lack of agreement about what kind of growth ( the sectoral distribution of growth, the rural and urban components of growth etc ) over what kind of timeframe will best lead India to a stage where the government can reach tax revenue to GDP ratios that will help it sustain crucial development efforts and welfare systems. The elitist bias of the recent decades in Indian economic policy is not conducive to the creation of broad-based growth. Continuation of the same bias can lead to a stagnation of tax revenue to GDP ratios. It is time for intelligent opinion in the country to realize the inconsistency between the need to run a well-funded modern government in a modern state and the large inequalities in economic growth between different sectors. It is also time to base economic policy on good projections of several important macroeconomic parameters and not base policy predominantly on overall GDP growth rates. Also, it is time for economic policy to be based on a better discernment of the differences between short-term and long-term economic dynamics. The same also holds for credit rating agencies trying to grade sovereign debt and other aspects of the economy.

by C. Jayant Praharaj ( send comments to cjpraharaj.blog@gmail.com )