India has been far more stingy than most emerging market peers in its economic response to the covid-19 crisis, and that may harm rather than help its sovereign ratings
In a recent interview, the chief economic adviser (CEA) to the finance ministry, Krishnamurthy Subramanian defended India’s limited covid-19 relief-cum-stimulus package, citing the fear of ratings downgrades in case of high fiscal slippages. Subramanian pointed out that most countries which have announced big fiscal packages have better ratings than India has.
A Mint analysis of fiscal packages offered across the world suggest that Subramanian’s statement is only half-true. While richer countries, which have better sovereign ratings, have indeed offered more generous support to their citizens and firms, there is considerable variation in fiscal packages announced by countries on the same ratings scale. Several countries that have similar or lower ratings than India have offered more generous fiscal packages, the data show.
The accompanying chart here is based on the sovereign ratings from S&P but the trend is similar even if one used the ratings assigned by Moody’s or Fitch Ratings. To be sure, the data here includes all government spending for covid-relief (including government guarantees on loans and reallocation of previously budgeted spending). Estimates by economists at Nomura suggest that new spending by most Asian economies is in fact quite smaller than the total spending announcement. Yet, even on that metric, India’s spend so far (about 0.5 percent of GDP or gross domestic product) is relatively low.
But if we consider Friday’s announcement of additional government borrowing of roughly 4.2 trillion rupees as indicative of a fresh stimulus program, India’s stimulus plans appear slightly more respectable. Estimates from Barclays suggest that the new borrowing (along with hiked fuel taxes) could offer the government room for an additional stimulus package worth 0.9 percent of GDP (after factoring in revenue losses because of the downturn in economic activity).
Nonetheless, a combined fiscal stimulus worth 1.4 percent of GDP might still be quite conservative compared to most emerging market peers.
One reason for this conservatism may lie in India’s relatively vulnerable fiscal position. India’s public debt and deficit (net addition to debt) numbers are considerably worse than most emerging markets, data from the International Monetary Fund (IMF) show. Yet, IMF’s latest projections for debt numbers, published last month, show that debt-GDP levels are expected to worsen for almost all emerging markets this year.
Thus on a relative scale, India’s debt-GDP ranking will not change much even if India borrows a bit more than what it does in other years, at a time when debt metrics for all countries are expected to deteriorate.
To be sure, this does not offer a license for unhinged borrowing or spending. But it does mean more room to deliver an impactful fiscal package. It is also worth noting that the evolution of the debt-GDP metric depends not just on the net addition to debt but also on the net addition to GDP. If the denominator (nominal GDP) falls more than expected, this will worsen debt-GDP levels regardless of how fiscally conservative a government is. And that’s the risk that India faces at this stage.
The ratings agency Moody’s highlighted precisely this risk in their note on India’s outlook dated 8 May. A significant worsening of India’s fiscal metrics would occur in ‘the context of a prolonged or deep slowdown in growth’, and would invite a ratings downgrade, the ratings agency warned.
If India’s fiscal stimulus is well-aimed to boost growth and is seen as a temporary aberration to deal with the ongoing crisis, it may not invite any ratings action, economists said. Rather, such steps might be needed to prevent a downward spiral in growth and ratings.
“There will be pressure on ratings because of fiscal slippages," said M. Govinda Rao, former director of the National Institute of Public Finance and Policy (NIPFP). “But the rating agencies will take into account the relative situation as well. Every country is undergoing a serious crisis, and fiscal metrics everywhere will be under pressure. This is a temporary aberration and if the government convinces the rating agencies that they have a credible plan to return to austerity, there may not be a downgrade."
Ratings agencies themselves appear to have factored in fiscal slippages in the current fiscal.
“The ability of emerging markets to use fiscal stimulus to support growth varies a lot," said Shaun Roache, chief Asia-Pacific economist at S&P. “In some cases, including India, high levels of debt and reliance on foreigners to fund current account deficits limits the space to cut taxes or boost spending. Still, using fiscal policy to limit the damage, especially to protect jobs, will be essential if policymakers set the economy up for a recovery later this year."
Measures taken by the U.S. Fed and other large central banks to boost liquidity have reduced upward pressure on the dollar, allowing emerging markets such as India more space to lower interest rates and raise public borrowing, Roache added.
The fiscal metrics are after all only one set of metrics that determine a country’s sovereign ratings. Growth and external vulnerabilities are other crucial determinants. Thanks to low oil prices and the cushion of a comfortable forex cover, India’s external vulnerabilities are low right now. So far, growth downgrades for India have been in line with other emerging markets but the lack of an effective fiscal stimulus could change that in the coming months.
Without a credible plan to revive the economy, the government risks undermining growth as well as fiscal metrics. A sharp decline in growth over the medium term would crimp government revenues and lead to much wider deficits than anticipated. It would also likely add to the growing pile of bad loans, strain an already fragile financial sector, and raise the eventual bank recapitalization costs for the government. The risk of a sovereign downgrade will become much more acute under such circumstances. India would harm rather than improve her rating prospects by walking down that path.
At the moment, fiscal prudence demands higher spending, not belt-tightening.