Government Proposes, S&P Disposes

Ratings agency S&P Global Ratings isn’t buying the Indian government’s pitch for a rating upgrade. On Wednesday, it reaffirmed India’s rating, with a stable outlook. Following the latest review, India’s rating remains at the lowest investment grade (BBB-) with no hope of an immediate upgrade.

Essentially S&P has rebuffed government officials, many of whom have been arguing that India needs to be rated higher. Officials have pointed to the fact that India has managed to push through a number of key reforms and that rating agencies should take this into account.

“If rating agencies don’t recognise these changes, they would indeed be missing out on the real India story,” economic affairs secretary Shaktikanta Das told Financial Express in an interview on August 17.

Rating agencies, however, appear to be unmoved.

We note the reforms but structural constraints, in particular, weak government finances, are yet to be addressed, is the core message that emerges from S&P’s latest review. Incidentally, S&P had clearly communicated to the government that what matters most to ratings is the fiscal position. Following a review in February 2015, S&P had said “improvements in India’s weak fiscal balancesheet are likely to be gradual and thus unlikely to lead to a rating upgrade in the next three to five years...”

The rating agency has stuck to this stand.

One of things that S&P highlights is India’s habit of running high fiscal deficits. That habit has not gone away and it has yielded little in terms of benefits.

India has a long history of high general government fiscal deficits (averaging 8.8% of GDP over the past 20 years and 7% in the past five years), said the rating agency. It added that these deficits have not closed India's sizable shortfalls in basic services and infrastructure, which is typically cited as a benefit of running higher deficits.

While India has steadily reduced its central government fiscal deficit post the global financial crisis, state deficits have remained elevated. Also, the government seems to struggle to meet its fiscal targets year after year and depends on non-tax revenue sources like public sector divestment or revenue from one-offs like spectrum auctions and income disclosure schemes.

The current fiscal year, when the government is targeting a fiscal deficit of 3.5 percent of GDP, is a case in points.

In the first six months of the year, the government has already exhausted 83.9 percent of its budgeted deficit. This has led to concerns on whether central government capex will be impacted, which in turn would hurt growth in an economy which is already starved of investment. Central government capex declined more than 16 percent year-on-year in the first quarter of the current fiscal, noted Shubhada Rao, chief economist at Yes Bank in a report on Tuesday.

Years of running high deficits has also led to the accumulation of government borrowings (about 69% of GDP, net of liquid assets) and debt servicing costs (over a quarter of general government revenue), said S&P.

What helps the government here is the captive investor base it has in the form of Indian banks. The statutory liquidity ratio, which is the mandated proportion of government bonds that banks have to hold, remains high at 20.75 percent of total deposits. This has meant that the government has never struggled to raise funds domestically and has been lulled into comfort on its borrowings.

To be sure, the proportion of government borrowings is not impacting the cost of credit or flow of credit to the private sector at present. But this is only because private demand for investment credit is low. If private credit demand picks up and government borrowings remain high, cost of raising funds from the market will inevitably rise.

An added (and very real) concern raised by S&P is the funds the government needs for recapitalising state owned banks. While the government has currently set aside $11 billion, S&P estimates the capital requirement to be four times that amount at $45 billion. No one knows where this money will come from, although S&P does not see this as a contingent fiscal risk yet.

S&P’s rating review should also serve as a note of caution at a time when the government is reviewing the Fiscal Responsibility and Budget Management (FRBM) Act. The committee taking a relook at the fiscal roadmap will submit its report this month and is expected to recommend a fiscal deficit range.

This may very well be seen by rating agencies as the government’s attempt to give itself more wiggle room to manage its finances and further damage India’s case for a rating upgrade.

For now, all government officials can do is maintain a brave face in response to S&P’s unwillingness to yield to the demand for a rating upgrade.

There is a disconnect between the perception of rating agencies and investors, said Shaktikanta Das after the decision was made public, reported Bloomberg News.