New Delhi: Within a week of the dramatic policy changes announced by the government, the international rating agency Standard and Poor’s (S&P) scaled down the country’s growth projections and warned that in the worst-case scenario it could even drop below 5%, signalling that more needs to be done to fix what’s wrong with the economy.
The rating agency’s grim forecast emphasizes that a sudden turnaround in the growth trajectory is unlikely in the current fiscal, even though prospects for the medium term are bright if the government is able to press ahead with structural reform initiatives such as the introduction of the single goods and services tax.
On Monday, S&P forecast that India would grow at 5.5% compared with its more optimistic projection of 6.5% earlier. This is part of the downward revision in growth projections it has made for countries in the Asia-Pacific region in the light of global risks arising from the slowdown in China, ongoing troubles in the euro zone, and weaker recovery in the US.
In April, the rating agency had warned that there was a one-in-three chance of a sovereign downgrade to junk status if the “external position continues to deteriorate, growth prospects diminish, or progress on fiscal reforms remains slow in a weakened political setting”.
While S&P revised India’s sovereign credit outlook to negative in April from stable, another rating agency, Fitch Ratings, also did the same two months later, blaming rising risks to its growth potential and limited progress on fiscal consolidation adding to macroeconomic woes. India currently has the lowest investment grade rating of BBB-.
The risk of a rating downgrade will not go away just because the government has announced a diesel price increase, said Indira Rajaraman, a professor at the National Institute of Public Finance and Policy and a member of the Vijay Kelkar committee set up by the finance ministry to suggest measures for mid-term fiscal correction.
“The government has to show consistent effort towards fiscal correction and keep all its macroeconomic indicators range-bound,” she said.
Along with its decision to allow freer foreign investment in retail, aviation and broadcasting, the government also raised the price of diesel by Rs.5 a litre and capped subsidized cooking gas to six cylinders per household in a year.
Though both the fiscal and revenue deficits may deteriorate next fiscal as it will be a pre-election year when government expenditure typically rises, Rajaraman said the Kelkar committee did not recommend frontloading a fiscal correction this year as it would have been too severe. “We have recommended fiscal correction evenly over a three-year period,” she said.
However, Abheek Barua, chief economist at HDFC Bank Ltd, said the chances of a sovereign downgrade are fairly low. A “5.5% growth forecast should not be seen as a sign for rating downgrade. It is an independent macro forecast that they have made. I think the proposed power sector debt restructuring (approved late on Monday), implementing Kelkar committee recommendations, and the plan for direct cash transfer should convince the rating agencies about the government’s resolve of ensuring creditworthiness”, he added.
However, Barua said the latest measures announced by the government will not be immediately reflected in the gross domestic product (GDP) numbers. “Though the measures announced are extremely encouraging, it will take six-eight months to manifest,” he added.
The government will move on a number of fronts with a tailwind of positive reaction from the private sector, though measures that require legislative approval such as the goods and services tax may be difficult to push through, said Tushar Poddar, managing director and India economist at Goldman Sachs, in a report on the Indian policy changes released on Monday.
“We think that reforms that require legislative approval, such as FDI (foreign direct investment) in insurance and pensions, land acquisition and reforms in mining, may be more difficult to introduce as they require a majority in Parliament and have been delayed for several years now,” he said.
Barua said that unless issues such as land acquisition, labour availability and the entire business of project implementation are resolved, growth may not recover sharply.
S&P said if downside risks to the Indian economy materialize, growth could slow to 4.3%; on the other hand, with some positive momentum, growth could touch 6.7% in 2012.
Finance minister P. Chidambaram said last week that India’s expected GDP growth may be somewhere between the Reserve Bank of India’s estimate of 6.5% and the Prime Minister’s economic advisory council’s 6.7%. In the first quarter of the current fiscal, the economy grew at 5.5%.
S&P said in its report that deficient monsoon rain has affected India, for which agriculture still forms a substantial part of the economy. “India’s slower growth is a combined result of a 15% deficit in rainfall for June-September and a forecast 0.6% worsening of the euro zone,” it added.