Not quite a capitalist conspiracy

ON the face of it, Standard Poor8217;s downgrading looks a bit like a grand capitalist conspiracy. The NDA government didn8217;t allow D...

ON the face of it, Standard 038; Poor8217;s downgrading looks a bit like a grand capitalist conspiracy. The NDA government didn8217;t allow Disinvestment Minister Arun Shourie to sell off HPCL and BPCL in which foreign companies like Shell have an interest, nor did it hike investment limits for foreigners in sectors like insurance and aviation along the lines of the N.K. Singh panel and so, the story goes, the capitalist world has sent a message to us.

After all, the argument goes, India8217;s got huge forex reserves of 62 bn, we8217;ve never reneged on foreign debt indeed, we8217;re encouraging firms to pre-pay their foreign debt, and we8217;ve grown at a healthy 5.8 per cent in the last 12 years. And as far as the swelling domestic debt burden is concerned 8212; one of the reasons cited by Standard 038; Poor8217;s for the downgrade 8212; isn8217;t it a fact that interest rates in the country are coming down? Surely that8217;s a sign that things are still manageable?

In any case, only someone very perverse, with 8216;poor standards8217; if you will, would club India with countries like Bulgaria, Costa Rica or El Salvador 8212; those are the countries which share India8217;s new status. Besides, since there8217;s very little borrowing being done right now, the impact of an S038;P downgrade is at best limited. That8217;s a word of caution for those in the stock markets: don8217;t panic as it isn8217;t going to affect forex inflows in any material manner. And even if the forex reserves fall a few billion dollars, it may even be a blessing in disguise, since India spends a lot more to maintain the reserves than it gets from investing them.

But, having rubbished Standard 038; Poor8217;s, there is no doubt about the fact that, thanks to the kind of fiscal profligacy not seen in a long time, India8217;s debt-bomb is simply ticking away, and in many ways, the fiscal situation is back to where it was during the crisis of 1991. Since the government is completely unable to cut expenditure, the fiscal deficit of both the Centre and the states is back to around 10 per cent of GDP, or the level it was when the 1991 crisis hit us. Just the central government8217;s internal debt, which fell from 50 per cent of GDP in 1991 to a more manageable 45 per cent in 1996-97, is today around 58 per cent 8212; add to this, the debt of the state governments, and the figure8217;s a whopping 80 per cent.

Look at it another way, over half the government8217;s expenditure is spent on just debt servicing each year. You can imagine just how much this leaves for spending on productive areas.

Clearly, that8217;s a huge problem. But are we headed towards a debt trap, in the manner S038;P seem to fear? In classic terms, that8217;s a situation where your expenses on borrowing are higher than what you earn. Right now, things still look manageable.

The government is paying an interest rate of over 8.5 per cent on its overall borrowings the rate on the new ones is 7 per cent 8212; now as long as GDP is growing by 10-11 per cent in nominal terms, the problem is manageable. Problem is, growth has slowed down in recent years, and is down to around 9 per cent right now. So the situation becomes a bit touch and go, and that8217;s what S038;P8217;s downgrade really means 8212; it8217;s not an immediate crisis, but has the potential of becoming one if things are not fixed.

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Clearly, if India8217;s growth rate picks up, the problem gets lessened, and S038;P8217;s downgrade will look like more of a capitalist conspiracy. The problem, however, is that growth is just not picking up, and it8217;s not just because of this year8217;s drought. The main reason for growth not picking up is that the government has not reformed enough. Since the government8217;s annual borrowings, for instance, are equal to 10 per cent of GDP, this drives up interest rates, and makes the cost of capital too high for industry. So, growth gets compromised because of the government8217;s inability to curtail its expenditure.

Similarly, the lack of reforms in the power sector has ensured two things 8212; one, there8217;s not enough power for industry and two, it8217;s too expensive. Slowing down of privatisation, apart from driving off potential investors both in India and abroad, also means that PSUs will continue to bleed the exchequer for some more time to come. Again, it8217;s overall growth that is suffering.

And, when it comes to the privatisation debacle of last fortnight, what8217;s the central message that comes through? Sure, the sales getting scuttled was a bad sign, but the real message was that outsiders what everyone calls 8216;corporate interests8217; could derail a government policy cleared seven months ago 8212; the Cabinet Committee on Disinvestment had cleared the sale of HPCL and BPCL in February itself. And, if the government could buckle under pressure once, it could do the same again, and again 8230;

Standard 038; Poor8217;s just raised the mirror for us. If we don8217;t like what we see, that8217;s hardly its fault. Chew on that.