Not rosy enough

After 'Brics' and 'India Shining', it was only a matter of time before credit rating firm Moody's Investor Services upgraded India's foreign currency ratings.

And since that is precisely what Moody's has done, though a few days after Fitch Ratings announced an upgrade, Finance Minister Jaswant Singh laconically described it as 'der aaye, durust aaye' (better late than never).

Quite rightly so, for if there is one thing India hasn't had for a long time, it is a foreign exchange problem.

Apart from the huge foreign exchange reserves, the maturity profile of our external debt is around nine years on an average, and the liquidity risk as reflected in the short-term debt as a percentage of its foreign exchange reserves is substantially lower compared to many of the crisis-prone countries. Moreover, the rupee is not overvalued, and India still has capital account controls.

Yet, it would be foolhardy to assume that all is well with the economy and that the economy is no longer vulnerable to a foreign exchange crisis.

Indeed, the unchecked growth of the fiscal deficit and government debt continue to pose a serious risk, and that is why, even after the upgrade, China is still five notches higher than India, South Korea three, and Malaysia two.

Even South Africa, Mexico, Tunisia and Mauritius are one notch higher than India, which is now on a par with Russia and Kazakhstan.

An excellent analysis of how the deficit-debt problem can move towards a deeper crisis is provided by Nouriel Roubini of the Stern School of Business and Richard Hemming of the IMF in a paper presented at an NIPFP-IMF conference last week.

They point out, for instance, that India's fiscal deficit and public debt are higher than even for countries with a lower rating "" the average debt ratio for Ba1 to Ba3 countries was 61 per cent in 2003 as compared to India's 85 per cent, the average fiscal deficit for similarly rated countries was under four per cent of GDP as compared to India's 11.5 and the public debt as a percentage of revenue receipts was 430 per cent for India as compared to 289 per cent for similarly ranked emerging economies.

At 35 per cent, the share of government debt as a proportion of bank assets is also higher than countries that have had financial crises, and it doesn't help that there is a term mismatch in the assets and liabilities of the banking system.

From here to a foreign exchange crisis is a matter of some assumptions that seem alarmist, but needn't necessarily be so. In any case, it would be prudent to keep them in mind.

After all, a spiral in debt and deficits does accentuate the chances of a foreign exchange problem. Roubini-Hemming cite the ominous example of Argentina, when investors began to be concerned about the sustainability of debt in 1997, after the economy had recovered to growth rates of over eight per cent, but the fiscal deficit remained. Guess whose growth rate has gone up to eight per cent along with the fiscal deficit worsening?