Quite obviously, the Reserve Bank of India, while reviewing the credit policy — the mid-quarter review is scheduled for later on June 18 — would take note of the recent developments affecting the economy. As it happened last week, there were not only planned releases of important statistical data, but some quite strong, unanticipated criticism of the government’s economic management — by global rating agency Standard and Poor’s (S&P).
On Tuesday last, the CSO released its IIP data for April, while on Thursday the monthly inflation statistics for May were announced.
Each of these data has large meanings for macroeconomic management, including, of course, the monetary policy. The caution by S&P, without altering India’s credit rating, has pointed towards the growing negative perceptions of India’s growth story among an important class of global investors.
Implications of S&P’s warning
It is the context as much as the content of S&P’s caution on the Indian economy that needs to be analysed to examine its real impact. It is true that the S&P’s unprecedented broadside on the UPA government’s style of functioning has made headlines. Less noticed, however, is the fact that the agency has not lowered India’s rating, which still remains at investment grade, though barely so. In April, S&P had lowered the rating outlook to negative from stable due to lower growth prospects. In the assessment of many economists, there has been steady erosion in India’s external liquidity while within India, the fiscal space, for important policy measures, is fast diminishing.
The negative outlook also took into account the possibility that India’s policymakers might be unable to react to economic shocks quickly and decisively to maintain the country’s current credit worthiness.
In April, S&P had downgraded India’s economic outlook. Government spokespersons have been right in pointing out that there have been no significant deterioration in India’s key economic parameters between April and now to warrant an unprecedented warning by the rating agency.
In fact, on one of the key issues that has impacted negatively on investor perceptions — the growing policy paralysis and indecision in economic decision making — the government displayed a measure of assertiveness by announcing less than two weeks ago a stimulus programme, which is estimated to cost Rs.2 lakh crore during the current year alone.
Obviously, one waits for the follow-up action and more details on how such large sums will be raised. Besides, there are big question marks over the PPP model (public-private partnership) that the government is betting on to implement the projects.
But if the government’s efforts bear fruit, they will mark a big step in meeting the serious shortage in physical infrastructure. Hopefully, a more immediate gain would be an enhancement of the government’s image in the eyes of investors and others, who have, over the last two years, become extremely sceptical of government’s efforts in the economic decision making.
The S&P’s caution has been widely noticed for two other reasons:
First, it has been issued at a time when India’s economic woes are mounting. GDP growth has slowed down to its lowest levels for any quarter in the last nine years. It clocked 5.3 per cent in the fourth quarter of 2011-12. Export growth in April is in single digit. Industrial activity at the start of this fiscal year has been marginal. In April, IIP grew by 0.1 per cent while capital goods growth contracted by 16.3 per cent for the second consecutive month.
Second, the rating agency has compared the Indian economy with those of other three BRIC countries. (BRIC, an acronym coined by Goldman Sachs, includes Brazil, Russia, India and China, all fast growing economies which are expected to lead the world economy.) Within the group, however, India fares the worst in terms of many economic parameters. Although S&P still retains the investment grade, it is ranked lower than the other three countries.
The acronym BRIC served a purpose but its presumed exclusiveness has been challenged. Countries such as South Africa, Nigeria and Indonesia have begun to show their vast potential. India may not lose the membership of such a club but will have to reckon with an expanded list of members.
The RBI, in its review, may not take notice of the S&P warning but obviously will be concerned over its likely impact on the external economy.
Even if India’s rating has not been brought down to speculative category, there are concerns over the availability of funds at a reasonable cost to a country which runs a large current deficit as well as a fiscal deficit. Should the euro crisis deteriorate further, India’s external economy will be further stressed. India’s much vaunted forex reserves — now in the region of $290 billion — will not offer the kind of insurance cover it is supposed to provide. For one, European banks, which are at the epicentre of the crisis, have large claims: around $133 billion out of the $290 billion of reserves are owed to them.
There could be a fight of funds from India, as the European banks try to consolidate their balance sheets.
For many, interest in the credit policy review is usually centred on whether there is a cut in the repo rate or CRR. But these decisions also take into account the external situation.