Financial Daily from THE HINDU group of publications
Monday, Sep 30, 2002
Economy on yellow alert
THERE has been a considerable controversy about the recent downgrading of India's debt to "junk" grade status by the international rating agency, Standard & Poor (S&P). It is necessary to review the downgrading with a sense of proportion. International rating agencies have rated us before and will continue to "rate" us. That is all in the game.
Investment institutions in the United States and Europe are obligated to invest only in securities that are rated "investment-grade" by reputed rating agencies. In doing their job, the rating agencies, no doubt, take into account various factors, including the capacity of the entity rated to repay its debt as committed.
The rating agencies Standard & Poor and Moodys are bound to have recollections of the bad time they had in the year leading to the Asian crisis, when they failed to spot the coming failures of many sovereigns and entities. In fact, the failure of the rating agencies to downgrade the Korean Development Bank issue ahead of the crisis is reported to have led to millions of dollars of investments turning to junk.
Similarly, rating agencies had failed to warn investors in due time about the impending fall of the Thai economy. While the rating agencies may claim that they were not alone in their failure to predict the coming events, it is clear that the experience of Asian crisis has left a mark on their behaviour.
The points on which the recent downgrading by S&P has been done cannot be brushed aside as irrelevant or inaccurate. The focus of the rating agency's comments and conclusions is on the rising fiscal deficit and the backtracking of Governments on the reform process.
Not all the declamations about the country's sovereignty can erase the fact that our fiscal performance has been poor and our record on economic reforms does not carry conviction. The fact that the spokesman of the S&P focussed on the backtracking on divestment cannot be held against him. The recent dithering on divestment is surely bound to have an economic implication.
So, too, political factors have combined to defer a decision on the level of foreign direct investment in sectors of the Indian economy. A rating agency has no option but to take into account these developments.
More importantly, the S&P's downgrading of India should be treated as an alarm call to the financial policy-makers of the country. The fiscal deficit of the Centre and the States together is at nearly 10 per cent of GDP.
This figure itself would not be a cause for alarm if policies were in place to reverse the declining trend of revenues at the Centre and the States and equally importantly to curb the rising trend of expenditures at both levels.
Recently, the Housing and Urban Development Corporation (Hudco) decided to cut off additional lending to many States, because they have defaulted on their guaranteed obligations to repay Hudco.
This experience of a premier national entity in infrastructure financing shows State guaranteed bonds are placed at a considerable risk. In the face of such failures by the State Governments to honour their guarantees, the whole future of debt financing is clouded.
The failure to repay to Central quasi-Government authorities is indicative of the trend of fiscal irresponsibility and speaks poorly of the financial management of the States concerned or unconcerned, as the case may be. It also closes the door on the prospects of financing infrastructure projects through special purpose vehicles, which are authorised to raise State guaranteed bonds at relatively low rates of interest.
The grapevine in Mumbai has it that many State Governments have already started defaulting on payments to national level financial institutions, which have generously funded them for such projects already.
The fact is that the root of the problem is the failure of the political authority to raise user charges, to cover principal and interest repayments.
The culture of default to national PSUs and financial institutions is spreading. Government of India should look into this and arrest this trend. S&P has, indeed, done a signal service to India by highlighting the resulting fragility of the fiscal and debt situation of the country. It is entirely open to the spokesman of the Government to have tried to convince the representatives of the rating agency about the facts of the matter and to carry the message of a credible (in their view) financial situation to the rating agency. I recall that in the crisis year of 1990-91, we did undertake such an effort with one of the New York-based rating agencies and we found that there was substantial meeting ground during the discussions. The rating agency appreciated the special circumstances, which had led to the impasse in which India was placed then and desisted from further downgrades in the light of the actions being taken by the Government .
It is possible that India's representations to the rating agencies had fallen on deaf ears. But it is necessary that such representations be made public. Transparency would definitely help in our case for reconsideration. After all, while we have not too good a fiscal record, we have gathered a few brownie points on our export front, foreign debt and, above all, in our current account balance.
We should not fight shy of trying to persuade the rating agencies of the positives that may help to relieve the overall gloomy picture that the fiscal surveillance represents.
It is a different question whether the brighter prospects on the external front will survive a continuing fiscal deterioration. Rather than recriminations, a dialogue with the rating agencies is the need of the hour. Abuse is no way to conduct economic dialogue.
Let me not be mistaken as saying that rating agencies are infallible. But the increasing dependence on the rating agencies, particularly in the context of the role given to them in the new Basle standards, would indicate that there may even be a need for international authorities to rate the rating agencies. Be this as it may, we have to recognise that what rating agencies say does matter and can have an influence on capital flows of various kinds.
It is, no doubt, true that the latest S&P's rating may not have much of an immediate impact on India as it concerns domestic debt into which foreign flows are limited. Nonetheless, the rating downgrade is one of the benchmarks for India's financial management.
We have to react positively and prove by our economic and fiscal policy corrections that the rating agency may have been in the wrong. Talking them down or abusing them is a sign of immaturity. It is up to us to demonstrate, through our performance, that S&P's characterisation of India's status as a "junk" is totally uncalled for. It is through our performance that we should answer the Standard & Poors of the world.
It is relevant to recall our earlier brushes with rating agencies' downgrading of India. In 1997-98, tempers rose about Moodys' downgrading India's sovereign grade from "stable" to "negative". At that time, the downgrading had sent Parliament into a state of agitation. The Members of Parliament had taken a dim view of Moodys' 49-point questionnaire to the Government which was a part of the process of rating.
Mr Atal Bihari Vajpayee, as Leader of the Opposition, had then said rhetorically that it used to be the World Bank and the IMF that impinged on India's sovereignty, but now it was a private agency. This time around, Mr Vajpayee has been otherwise busy handling graver threats than rating agencies. It is a fact that no sensible observer can deny that S&P's rating, although apparently drastic, provides a responsible reaction to India's prospective and present policy failures. It is a warning that, as a country, we are teetering at the edge of a fiscal collapse and a debt explosion.
Hard-headed economic policy decisions, which involve raising user charges, reduction of subsidies and taxation measures as well as divestment on an aggressive scale these are essential if we are to address the current frailty of the Indian fiscal and economic system.
We may even have to acknowledge that the rating agency has indeed performed a signal service to India in highlighting the potential dangers of our continuing complacency in economic policy. We can trash rating agencies only if we improve our performance. To fault them for highlighting our frailties is a disservice to ourselves, in the long run.
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