Reform and revive or pause and perish

The subtle but succinct message from Standard & Poor’s (S&P) is quite loud and lucid: Reform or perish.

Revive and rekindle the policy prescriptives, currently consigned to the back burner, to fire the engines of the economy.

Or let the current policy paralysis be allowed to prolong at the country’s own peril. Yes, indeed, S&P’s India rating outlook to negative from stable could not have come a day sooner.

After issuing a similar warning earlier this year about a negative tilt in India’s sovereign credit rating, if actions were not taken to counter the risk emanating from economic uncertainties, the rating agency has sounded the warning bugle decisively before things take to the worse.

The reasons for S&P’s pessimistic posturing are not too far to ponder. The large fiscal deficit, the prolonged delays in the economic reforms caught in the conundrum of politics, and policy inaction due to various scams that have pushed the government and its bureaucracy on the backfoot, are being played out on the political amphitheatre for quite some time now.

That another renowned agency, Moody’s, however, has maintained its ‘stable’ rating on the country cannot be much of a solace given that the government is quite well aware of the compulsions that have it in shackles and put it in a bind.

So much so, the government, while quick to issue instructions not to get panicky to douse any repercussions by the downgrade, has, however, wisely been not dismissive of S&P’s observations conceding that corrective steps are needed sooner than later.

But, the question that begs an affirmative answer is whether the rating agency is fully justified in revising India’s outlook to negative using the same parameters on which the other agency has not done so. Analysts say, given some of the crosscurrents India is facing, the rating agency’s actions are indeed justified.

Despite having slow economic growth and the government’s expenses overshooting revenues, rendering its finances into a precarious state, the UPA dispensation has done little on the policy front. “Remember, credit rating agencies do not change their outlook on a daily or weekly basis.

They take stock of the situation and then go ahead and the underlying drivers of that change are not new,” observed JRG Finance’s Harish Galipalli. The underlying weakness in the economy is because of the government moving slow on reforms.

Hence, the unanimous opinion among policymakers and other stakeholders is that the government should move fast on the oil and subsidies-front and pass on the burden to the consumers. Else, the pressure on the fiscal will be so much that it will only fan inflation further.

Corruption charges

But the government, struggling to overcome corruption charges, recalcitrant allies and an opposition looking for opportunity to put the UPA coalition on the mat, is finding it difficult to push through reforms aimed at reviving the slow pace of the economy.

And, here S&P’s other observation that only a modest progress in fiscal and public sector reforms in the coming years can also not be dismissed, according to experts, some of whom have also drawn a parallel between S&P’s observation and Chief Economic Advisor Kaushik Basu’s statement.

At a recent Washington lecture, he had said that economic reforms in India were unlikely to pick up before the 2014 national elections.

Basu too had said that relatively less important bills might go through Parliament but major economic reforms would hit the roadblock. Of course, Basu has subsequently issued clarifications after a political storm back home generated enough heat on his statement.

But what about the evident signs of some macro-economic indicators losing sheen? For example, a soaring current account deficit (CAD), rising trade imbalance and the rupee depreciation from 49 to 52.5 in a span of a few months.

The foreign institutional inflows have fallen from $9.2 billion in February, 2012 to $1.7 billion in March and further to $122 million in April.

Although, India had a robust foreign direct investment flow in the year gone by, economy watchers fear that this too could take a hit by the retrospective changes in tax laws.

The investment climate in the country has not shown any improvement either and investor sentiment has taken a beating after a U-turn in the government’s decision on opening the retail sector to foreign investors late last year.

Although, the government subsequently took a decision to open single brand retail to overseas investors, it has attracted very little investment since then.

According to government’s own admission, the country has received only one proposal for single brand retail licence to operate in India worth Rs 100 crore.

This has come four months after the FDI cap in single brand retail was increased to 100 per cent in January, paving the way for global brands and retailers to have full ownership of their Indian operations. Footwear and accessories player Pavers England has applied for retail licence to operate in India.

Other reforms such as allowing foreign airlines to pick up stake in domestic carriers, and FDI in defence, which have a direct bearing on the country’s growth, are still waiting to be cleared for a long time now.

Other pressing financial sector reforms such as introducing a nationwide goods and services tax, rationalising fertiliser and fuel subsidies, and expanding the scope of foreign investment in retail, banking and insurance are pending or moving slowly.

Political gridlock

Then, there are uncertainties in environmental clearances in coal and other mineral ore extraction projects, all because of the government’s inability to break the political gridlock affecting decision-making on these measures. The experts are also of the opinion that Finance Minister Pranab Mukherjee’s assurance of no panic on S&P’s observation may hold little ground.

No doubt that India’s economic fundamentals are strong. The country has comfortable foreign exchange reserves and its external debt situation is also better, but there are newly emerging problems of zooming trade deficit and a higher than manageable current account deficit close to 4 per cent of the gross domestic product, which is exerting pressure on the rupee.

The government has taken some policy measures to enhance the country’s overseas shipment in the past couple of years, which is expected to prove handy in correcting the trade deficit and the resultant current account deficit. But, going forward, according to analysts, these alone are not enough.

They want the RBI to protect the rupee being pressured by a high CAD. In this situation, the most viable solution appears to be enhancing exports and correcting the trade balance, said eminent economist and former Jawaharlal Nehru University Vice-Chancellor B B Bhattacharya.

The balance of trade is typically the most important part of the current account. A positive net sales abroad generally contributes to a current account surplus and the vice versa to the deficit.

Because exports generate positive net sales, and because the trade balance is typically the largest component of the current account, a current account surplus is usually associated with positive net exports.

“All these measures plus a positive note on government’s reform agenda can propel economic growth and reduce the fear of falling into a deficit trap, be it fiscal, trade or current account,” Bhattacharya said.

Other economists too opined that a move in the right direction on reforms can only wither away the threat and caution sounded by S&P on India’s medium and long-term growth prospects and its warning to downgrade the country’s rating.

But, they were also concerned about the government’s excessive reliance on social sector reforms, the biggest being the Food Security Bill, which may become a reality before the UPA enters into the 2014 general election mode.

Analysts said that it will only add to the ballooning fiscal deficit of the Centre and may throw government’s finances into a disarray. The raising fear of the S&P rating downgrade, in times to come, will depend on how the government curbs its expenditure and raises domestic consumption, especially at a time when external economic situation is highly uncertain.

For now though, the writing on the wall is clear: It’s time to act before it is too late: elections or otherwise.