A loosening in fiscal policy ahead of elections can further weaken public finances

Fitch Ratings on Monday warned that India’s sovereign rating could be cut if the government loosens in fiscal policy ahead of the general elections in 2014 and sees a prolonged fall in its growth rate.

“A loosening in fiscal policy ahead of the elections could further weaken India’s public finances and put pressure on the ratings. …….. Policy slippage and/or mounting evidence of a structural decline in the trend growth rate, such as protracted relatively weak economic data, could cause the ratings to be downgraded,” Fitch Ratings said in a release.

“Our affirmation of the ‘BBB-’ rating in June reflected India’s diversified economy and high domestic savings. An improved investment climate that supported greater infrastructure investment, and a sharp sustained decline in inflation, would support the rating,” it added.

However, “India’s track record of delivering on fiscal policy goals is not encouraging,” according to Fitch Ratings. Even though the government announced various plans for economic reforms and enhance growth “it has gone off track before with similar plans, such as that under the Fiscal Responsibility and Budget Management Act of 2003 or in the Thirteenth Finance Commission report of 2010.”

Fitch and Standard & Poor’s this year had cut their ratings on outlook for India to ‘negative’. Meanwhile, the other international rating agency, Moody’s, said last Tuesday that the outlook on India is ‘stable’.

India’s third-quarter (July-September) gross domestic product (GDP) reading last Friday demonstrates the slowdown in the country’s performance, Fitch Ratings says. Recent reform proposals, while potentially growth-supportive, need time to work and face political risks to their implementation.

“We expect the economic recovery to be shallow. We forecast real GDP growth to fall to 6 per cent in 2012-13 from 6.5 per cent in 2011-12, before recovering to 7 per cent in 2013-14. This compares with an 8.4 per cent rise in 2010-11.”

The Indian economy grew by 5.3 per cent in July-September versus a year earlier, down from 5.5 per cent in April-June. The fall in merchandise exports and merchandise non-oil imports in October also points to the economy’s struggle to return to previous growth rates. However, tight fiscal and monetary policy settings decrease the authorities’ scope to support growth amid stubbornly high inflation and a commitment to consolidating public finances.

“Evidence of slowing growth has been accumulating in 2012, and has been consistent with a cyclical slowdown. However, India also appears to be facing structural challenges to its investment climate”.

“As we said in June when we revised our Outlook on its ‘BBB-’ rating to negative, India’s medium- to long-term growth potential could gradually fall if further structural reforms that would improve the operating environment for business and private investment are not speeded up,” it added.

“But political and implementation risk remains considerable.” Several proposals still require legislative approval, and policy reversals cannot be ruled out. The approach of general elections in 2014 mean there is little time to fully enact reform. These risks are reflected in the negative outlook.

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