Post interim budget, the threat of a downgrade remains

standard and poor'sVivek Kaul
On February 28, 2013, the finance minister P Chidambaram, presented the budget for the financial year 2013-2014 (April 2013 to March 2014). In this, he projected a fiscal deficit of Rs 5,42,499 crore or 4.8% of the gross domestic product (GDP). Fiscal deficit is the difference between what a government earns and what it spends, expressed as a percentage of the GDP.
All through the year, Chidambaram maintained that come what may the government won’t cross the fiscal deficit of 4.8% of the GDP. In the end he stood by his promise, but only on paper. The fiscal deficit for 2013-2014 is now estimated to be at Rs 5,24,439 crore or 4.6% of the GDP.
It was important that the government did not cross the target of 4.8% of the GDP that it had set, given the threat of a downgrade from international rating agencies.
The rating agency Standard and Poor’s (S&P) currently rates India as BBB-. This is rating is the lowest rating in the investment grade. If India were to be downgraded, its rating would fall to BB or the first stage of the junk status.
This would mean that a lot of foreign investors would have to sell out of the Indian bond market as well as the Indian stock market,given that they are not allowed to invest in countries with a junk rating. This would lead to huge pressure on the rupee as foreign investors cashing out will convert their rupees into dollars.
In fact, in November 2013, S&P had maintained the “negative” outlook on India. This meant that there were chances of a downgrade, over the next 12 months. As the rating agency had said in a release “The central government’s budget balance[i.e. the fiscal deficit], however, tells only part of the Indian fiscal story. Using a broader measure of general government deficits, we project a 7.2% of GDP deficit for fiscal 2014, to which one should add 1-2 percentage points of GDP deficits for the unprofitable portions of the consolidated public sector, including state electricity boards and oil-marketing companies.”
Keeping this definition of fiscal deficit in mind, how has the finance minister P Chidambaram done? It is safe to say that the fiscal deficit of 4.6% of the GDP is at best a hogwash. In order to arrive at that number, the finance minister has under-budgeted for petroleum, food and fertilizer subsidies in a major way. Estimates suggest that payment of more than Rs 1,20,000 crore worth of subsidies has been postponed to the next year.
Take the case of petroleum subsidies. Chidambaram had budgeted Rs 65,000 crore towards it. The number has now been increased to Rs 85,480 crore. Of this amount, a substantial chunk has gone towards payments of petroleum subsidies that should have been paid in 2012-2013( April 2012 and March 2013) but were postponed to 2013-2014.
In fact, data released by the Ministry of Petroleum and Natural Gas in early February shows that the oil marketing companies have reported under-recoveries ofa total of Rs 1,00,632 crore during the first nine month of 2013-14 (April-December) on the sale of diesel, PDS Kerosene and cooking gas. Hence, the Rs 85,480 crore budgeted towards oil subsides is clearly not enough.
On the earnings side, Chidambaram has indulged in massive asset stripping to match his numbers. He has forced public sector banks, which are in a financially fragile state, to pay interim dividends of close to Rs 27,000 crore. ONGC and Oil India Ltd have been forced to pick up shares worth Rs 5,000 crore in the loss making Indian Oil Corporation, a company which no private investor wants to touch. And the government has also managed to get more than Rs 19,000 crore from Coal India, as dividend and dividend distribution tax.
Anyone who understands some basic accounting will tell you that using assets to pay for regular expenditure is never a great idea. Rating agencies like S&P obviously understand this. And that is why it had said in November 2013 that using broader measures, the fiscal deficit comes to greater than 7.2% of the GDP. In that sense, the deficit of the government is clearly greater than the 4.6% of the GDP that it has arrived at, once the accounting shenanigans are taken into account.
Given that, the threat of a downgrade remains. As S&P had said in November “we expect to review the rating on India after the next general elections when the new government has announced its policy agenda.” The agency plans to look at the fiscal policy of the next government as well, among other things. Given the mess the current fiscal policy is in, it will be very difficult for the next government to do much about it. The only way out is to slash government expenditure massively. And that is easier said than done.

 The article originally appeared in the Daily News and Analysis (DNA) dated February 18, 2014 
(Vivek Kaul is the author of Easy Money. He can be reached at [email protected]

Downgrade fuss's overdone. Who cares?

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India’s fiscal deficit has reached worrying proportions. During the first six months of the year it had already crossed 65% of the year’s target of Rs 5,13,590 crore. Fiscal deficit is the difference between what the government earns and what it spends.
The government’s effort to raise revenues has barely gone anywhere. During the half of the year only 40% of the targeted revenues had been raised. The recent 2G auction was a damp squib and the disinvestment process has barely started.
So what is the way out? “You know you always find some way out. Nobody quite believes the fiscal targets as yet. It is still all about hope and let’s see what happens in the next few months,” says Ruchir Sharma, the head of Emerging Market Equities and Global Macro at Morgan Stanley Investment Management. “Only thing that which makes me sound a bit positive in terms of hope that at least they have recognised the problem. Till a year ago, even till April, there was no recognition of the problem. And that to me is at least a positive that we can look on.”
Given the slackening finances of the Indian government there has been a lot of talk about the rating agencies downgrading India, something, if media reports are to be believed, even the finance minister P Chidambaram is worried about.
But Sharma feels the threat is majorly overblown. “
I just feel this fuss about that is really overdone to be honest with you because who cares! They (the rating agencies) are far behind, so whether we get downgraded or not, to me it just doesn’t matter and that doesn’t change anything for us,” says Sharma.
Explaining his logic Sharma says “Let me put it this way. If growth is less than 5% etc, that would be horrendous. But I think the reasons for the downgrade are already well telegraphed. If it happens it will be a formality. It will be a short term negative undoubtedly.”
The other big worry in India right now is inflation. “Commodity prices are generally down globally and that should help inflation. The problem is the same that unless we put an end to this populist surge in terms of spending you can’t get a meaningful decline in interest rates,” says Sharma.
“That really is at the core of the problem as far as inflation and interest rates are concerned. How do you put an end to that culture? That genie is out of the bottle. How do you put it back in?,” he asks.
The main problem that remains for inflation is just that there is too much government spending going on and too much of it is inefficient, feels Sharma. “This at a margin is a problem that is getting better,” he adds.
But the real test for the government would be whether they are able to put off the food subsidy kind of schemes. As Sharma puts it “To me the real signal will come if they back down on these populist schemes. Such as the whole food subsidy bill etc. The real fear that I have now is that we do all this now and this is only preparing for another populist scheme at the end of it, at the first sign when things are manageable or things are brought under some control. The fact that they can postpone such things or put them completely away will be a very positive sign. But until then I don’t know.”
The realisation that needs to come in is that government spending as a share of India’s gross domestic product is too high. “You can’t carry on this way. Not because it’s bad thing to do but you can’t keep writing cheques which the exchequer can’t cash. To me that is the bottomline. That spending now for a country of India’s per capita income level of $1500, government spending as a share of GDP is too high.”
Government scams have also been a major issue in the recent past. Sharma feels that this does impact India’s perception in the West. “For them it reinforces the fact about two issues that they have had with India. One is the fact that it is a tough place to do business in. And that shows up in all the metrics like the ease of doing business that World Bank and IMF put out, India ranks in the bottom quartile of most of these things. It also highlights that in India it is very difficult to do greenfield projects and set something up. You might as well be a partner with one of these guys who can get stuff done in India,” says Sharma. “But this is something that people have known and this just reinforces their perception,” he adds.

The interview originally appeared in the Daily News and Analysis on December 3, 2012. 
(Vivek Kaul is a writer. He can be reached at [email protected]