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When you say rising trade deficit is credit negative, does it mean that you are going to take action on India’s ratings?
Our outlook on India’s Baa3 rating is stable. As part of our credit analysis, we continually monitor several ongoing trends that can affect a sovereign credit profile: some trends are credit positive and some are credit negative. India’s trade deficits have been rising over the last two years, and it is our opinion that this trend is credit negative. However, it is not the only factor we consider in our analysis of India’s credit profile.
What role will this factor play in deciding about your rating action on India?
Our rating and the outlook are based on our assessment of whether the balance of credit positive and credit negative trends are likely to change over time such that India’s credit metrics would no longer fit within its rating category. At this time, India’s external debt ratios compare favourably to those of many other countries rated Baa3. However, if the current trends in external deficits and debt continue, these ratios will worsen. Therefore, we continue to examine whether policy measures undertaken by the government recently, and likely to be undertaken over 2013, will eventually reverse the deterioration in the current account deficit or not.
You also blamed loose fiscal policy for stimulating demand that led to higher imports and higher trade deficit. But, trade deficit rose alarmingly in a month, January, when the government initiated measures for fiscal consolidation. How do you see this?
Fiscal policy actions are not immediately transmitted to external balances. For instance, fiscal policy could remain loose for some time, before the trade or current account deficit start to widen significantly. Similarly, fiscal tightening may have to persist for a while before the trade and current account deficit start to narrow.
As we’ve said in the report, fiscal policy is one of the three major factors that underpin the widening trade deficit – global demand and global commodity prices being the other two. It is the combination of trends in all three contributors to the trade balance that determines how the trade balance evolves. Given that global growth and commodity price trends are unlikely to change materially over the next few months, any change in the trade deficit trends will depend on the extent to which domestic policy changes.
Earlier, loose fiscal policy affected the trade deficit by raising demand for imports and eroding the competitiveness of exports (through higher inflation and higher private sector borrowing costs). Therefore, for recent fiscal measures to be reflected in external trade numbers, they will have to be consistently implemented such that they reduce import demand and enhance export competitiveness.
At what level do you peg India's current account deficit as percentage of GDP in the current financial year?
Given trends in the data so far, the trade and current deficits will both be higher in FY 2012-13 than they were in FY 2011-12. This worsening is already well known. From our perspective, what is important is the trend in both these deficits in FY 2013-14. That is, whether the deterioration in the trade and current account observed over FY 2011-12 and FY 2012-13 will be arrested and reversed in FY 2013-14.
You said increasing CAD will depreciate the rupee and will in turn make imports expensive which will raise inflation further. But, India imports products that go into manufacturing as well and inflation in manufacturing products have been coming down. Your take?
The abating of non-commodity inflation is largely due to lower demand growth resulting in lower pricing power (which is a natural outcome of lower growth, tighter monetary policy environment).
However, the cost of commodity inputs into manufacturing, such as fuel, has actually been rising — and a depreciating rupee suggests that even if global prices of these commodities remain stable, their rupee value will still rises. If input costs continue to rise, manufacturing output prices would eventually reflect them, particularly if growth (and thus pricing power) starts to revive.
