Ratings and resources

Economic recovery needs action, not hope

When the credit rating agency Standard & Poor's (S&P) came to New Delhi last month, the government laid out the red carpet for its analysts; senior functionaries argued persuasively that reforms were in hand and the Indian economy was on the brink of returning to a high-growth path. It appears that the government at its most persuasive has not made so much as a small dent in S&P's pessimism. On Friday the agency announced that not only was it not upgrading India's rating from BBB-, the lowest "investment-grade" rung, it was not going to change its outlook on the rating from negative, either. Indeed, S&P warned that unless India undertook major reforms in the coming year, the country would be downgraded next year. The full effects of a sovereign rating for India in junk territory could possibly be very large indeed. India is dependent, for financing its capital account deficit, on foreign institutional flows, which could dry up if India was no longer investment-grade. In addition, borrowing costs for Indian companies would go up, making an investment-led growth recovery that much more difficult. Thus, while it is easy to mock rating agencies as out of touch and inefficient - especially in the post-financial crisis era - it is not wise for New Delhi to ignore their pronouncements, as they retain significant power over real economic outcomes. However, the government, instead of worrying about what a rating agency might or might not do, should focus on what it already knows it must do in order to revive growth - a point made well by Chief Economic Advisor Raghuram Rajan on Friday.

S&P says its concerns about India are born out of the country's continuing troubles with its public finances, as well as the political gridlock that makes big reform impossible to push through. On the latter, it singles out land acquisition and the goods and services tax. It is possible that both those pieces of legislation will see significant movement in the months to come, so perhaps S&P's concerns are overstated. On the other hand, the agency is right to point out that the effects of the Cabinet Committee on Investment's push to clear held-up infrastructure projects are yet to be seen. But it is the matter of public finances that, perhaps, gives rise to most of the worries worldwide that S&P's analysts are distilling. While the Budget presented a few months ago does claim to return India to a path of fiscal consolidation, possibilities for slippage still exist, especially in a year leading up to general elections. The government should not only resist such temptations, but should also continue to reduce diesel subsidies as well as get to work on rationalising fertiliser subsidies.

The current account deficit should also continue to be in the government's sights. New Delhi seems to have palpably relaxed on that account of late, driven by a decrease in the prices of oil and gold, the two items that compose the largest parts of India's import bill. But the recovery of the current account deficit, as well of the broader economy, cannot be premised on softer commodity prices - which, after all, move in cycles and have been notoriously volatile over the past few years. In addition, as a recent JPMorgan report has pointed out, even if crude oil and gold stay at their current depressed levels, a large part of India's import bill is driven by other resources. Fertiliser imports have risen 30 per cent in the last two years, coal imports have doubled, and the iron ore supply crunch has led to a 50 per cent increase in metal scrap imports. These are problems that the government cannot expect will go away with oil and gold. India's resource economy needs fixing, and an economic revival cannot be accomplished without doing so.