That wasn't to be for long though. In a recent article in the Economist dated July 9th, 2009 and titled "India's budget - Hopes suspended," the author(s) resurrected that specter in more concrete terms. This time it was about the Government's Deficit just after Mr. Pranab Mukherjee, the Finance Minister, had presented the budget in Parliament.
Of most concern to investors, perhaps, was Mr Mukherjee’s admission that the central government’s deficit would widen to 6.8% of GDP in the year to March 2010. It now borrows 34 out of every 100 rupees it spends. Add the red ink of India’s state governments and various borrowings reported “below-the-line”, and India’s deficit could reach about 12% of GDP, according to Standard & Poor’s (S&P). The rating agency reminded investors that India was in danger of losing its investment grade.
India has weathered the global recession better than most. Its GDP grew by 5.8% in the last quarter of 2008, compared with the year before, and by the same amount in the first quarter of 2009. Almost 80% of that growth came from extra government spending, says CRISIL, an Indian rating agency. The government is not yet ready to tighten the purse-strings.
Despite strong growth and low interest rates, its public debt was still over 80% of GDP on the eve of the global crisis, worse than India’s peers (see chart). Now it is back to 85%, says S&P...
...according to the IMF, the government spent about as much on misdirected subsidies of fuel, fertiliser and food (3.7% of GDP) as on education and health.
That growth of 5.8% that had given so many people the warm cozies and proclaimed to the world that India was still growing when the rest of the world was in recession - was effectively a mirage. Eighty percent of it had come about as a result of "extra government spending" - at a time when the Government was ranked 127th in terms of its Deficit. Simply said, the government is spending, or is close to spending, money that it does not have - necessitating borrowing on its part.
But so what, we might ask. The US is also spending money that it does not have. The difference, I think, lies in the ability of the Government to tax its people - or at least to do so without choking off growth. We might counter this argument by saying that where the US has size (14 Trillion $ economy) and the World's Reserve currency on its side, India has the 4th best Domestic Market on its side. But I find this argument spurious. A good Market is only as good as the currency that underlies it - and the Rupee is, or will be, now under pressure. Worse yet, if the Indian Government doesn't get the house in order, the country risks having its rating reduced. From the Telegraph in an article dated March 11th, 2009, and titled "India can't afford junk rating" :
Standard & Poor’s responded to February's interim budget, which revealed a grim fiscal situation, by putting the country on watch for the loss of its investment grade status. In the middle of the global financial crisis, that’s bad news.
If global markets were stable, a junk debt rating wouldn’t cause India much pain. It has traditionally financed most of its budget deficit domestically, generates less than one-third of its $1.2 trillion annual GDP from exports and still has foreign exchange reserves of $250bn. The national government’s junking would raise borrowing costs for Indian companies – which cannot generally have stronger ratings than their home country...
Worse yet, if the Government's rating were reduced and subsequent reductions to Indian Companies were to follow, many International Investors would be forced to withdraw funds. For example, there could be rules limiting Pension funds from investing in companies that fail certain rating criterion. There is another side to this problem too - that of maintaining a stable Rupee/Dollar ratio. Government borrowing could soon put pressure on this. Although the Rupee is about 48 to the Dollar right now, it seems almost inevitable that the Reserve Bank of India will have trouble holding it down. From an article in Silicon India dated February 18th, 2009 and titled "India lost $43.2 Billion forex reserves in 5 months" :
India is among the worst affected countries losing foreign exchange (forex) reserves by as much as 3.5 percent of its gross domestic product due to currency imbalances in the past five months, said a study by an industry lobby [Associated Chambers of Commerce and Industry (Assocham)] released Wednesday.
From a peak of $315.6 billion in June 2008, India's forex reserves dropped to $248.6 billion in in January 2009. The Assocham attributed this fall to RBI's "strong measures" to stem the global pressures on the Indian currency. During the April-November 2008 period, RBI sold US dollars to the tune of $31.4 billion as against the net purchase of $55.2 billion in the corresponding period in 2007.
True that the article dates back to February, when the World looked like a much darker place, even so, the issues of then are more relevant now given that the Deficit has only gotten worse. The Government is counting on growth - induced by the Fiscal Stimulus - especially engendered in the rural areas. But there are problems there too. From an article just a few days ago in the Wall Street Journal dated July 17th, 2009 and titled "India Adviser: No Downside Risk Yet to GDP Aim" :
India's annual monsoon rains have been faltering and during June 1-July 15 were 27% below normal. Nearly 60% of India's farmlands are rain-fed.
A failed monsoon hurts not just farm output but also demand for everything from fuel and motorbikes to soaps and gold, adding pressure on a government struggling with a fiscal deficit that may balloon to 6.8% of gross domestic product this year.
Agriculture's share in the economy shrank to 17.5% last year from nearly 30% in the early 1990s, according to Morgan Stanley's estimates. But two-thirds of India's 1.1 billion population live in villages and rural demand accounts for more than half of domestic consumption.
In the long term, I would still maintain that India has a very bright future. The issue is the short term. In the worst case, if economic growth sputters AND the monsoons fail, will a Government which doesn't have the money be able to come to the rescue of the needy?
And if so... How? That is the question.
Rajnesh Domalpalli