Policymakers must be heaving a big sigh of relief at the decision of ratings agency Standard & Poor’s (S&P), to retain India’s sovereign rating at ‘BBB –,’ with a negative outlook. The skidding rupee, a high current account deficit (CAD), weakening GDP growth and rising inflation had set off fears of an imminent downgrade of the country’s sovereign rating. A downgrade would have taken India to below investment grade, which would have put off prospective investors and also raised borrowing costs for Indian companies abroad, compounding the existing problems. If this dire scenario did not play out, it is thanks mainly to the measures initiated by the Reserve Bank of India and the government to support the rupee and rein in CAD through a tight squeeze on non-essential imports. A simultaneous pick-up in exports and revival in FII fund flows, following the decision of the U.S. Federal Reserve to continue with its monthly bond-buying programme, certainly helped improve the external environment. Interestingly, S&P notes that “India’s external position is an element of strength for the rating,” a far cry from the situation just a few weeks ago. Yet, the fact is that the risk of downgrade has been seen off only temporarily, as the ratings agency has itself acknowledged in its report.
There still are several adverse economic variables for policymakers to be worried about. With the CAD now under check, the focus has shifted to the fiscal deficit and the question of whether the government will be able to stick to the target of 4.8 per cent of GDP for 2013-14 considering that elections are round the corner. Reining in subsidies on petroleum products and fertilizers is crucial to meeting the fiscal deficit target, but as we get closer to the elections it is doubtful if the government will be able to prune either. Added to this is the outlay on food subsidy, which S&P estimates will be as high as 1.5 per cent of GDP. Funding these subsidies would not have been a worry in an environment of strong economic growth but that is not the case now; the growth impulse is weak and both consumption and investment are at a low ebb. Falling demand has resulted in idling of capacities across a range of industries starting from automobiles to consumer durables. These problems acquire a different dimension when viewed along with the likelihood of political instability at the Centre post the general elections. And this is exactly the risk that the ratings agency is flagging for its negative outlook. A change in the outlook to ‘positive’ and warding off a possible downgrade would require a return of the growth impulse, resolute management of the fisc and stable monetary conditions — a tough ask indeed in an election season.