Unlike many natural disasters, economic crises are seldom accompanied with a warning bell. The story of a rating analyst’s pessimism even as Union finance ministry officials gave him an upbeat presentation is by now well known. What this episode reflects is that in spite of warning bells, India’s economic managers and their political masters continue to move on in a carefree fashion.
Last week, Standard and Poor’s (S&P) lowered its outlook on India’s rating from stable to negative. This was due, among other factors, to the country’s deteriorating fiscal position and widening current account deficit. While these three problems and the risks associated with them are well known, there are now two more factors that must be taken into account. The biggest concern now is that of slowing growth. The country’s retrogressive tinkering with tax laws is another.
Lackadaisical growth has now been around for a while now. In the third quarter of 2011-12 (Q3), growth fell to 6.1% (on a year-on-year basis), the fourth straight quarter in which growth has fallen. There is danger now that even the reduced 6.9% growth target for 2011-12 may be hard to achieve.
By itself, this would not have mattered when seen from a global economic perspective: even 6.9% growth is “respectable” in a world where growth has virtually vanished. But slower growth also means a slowdown in the government’s tax revenue and in the face a large fiscal deficit, the danger of its ballooning even further. When combined with spending pressures that are almost certain in 2013-14, for that is a pre-election year, the government’s ability to keep fiscal deficit down to 5.1% of gross domestic product is unlikely.
The other danger is from the pernicious changes in the country’s tax code. The government has not understood the dangerous implications of retrospective tax law changes: almost at one stroke, international investment sentiment for India has turned negative. This darkening of mood should be seen against the slowing of foreign direct investment (FDI) flows in the country since 2009-10. In the two years, 2009-10 and 2010-11, FDI flows turned negative. This alone should have prompted the government to take proactive steps to attract investment. Instead it has taken steps that will chase away investors.
Overall, growth and weak investment flows pose a serious threat to macroeconomic management in India. While oil prices, subsidies and government spending—tough as they are to manage—pose difficulties, weakening growth and investor pessimism are far more challenging problems to counteract. The warning from S&P should force the government to wake up.
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