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What S&P’s ratings downgrade really says about UPA 2

Written by Sanjaya Baru |
May 2, 2012 3:28:20 am

What S&P’s ratings downgrade really says about UPA 2

Within minutes of the news breaking that the sovereign credit rating agency,Standard & Poor’s (S&P),had signalled the likelihood of a ratings downgrade,India’s Union Finance Minister Pranab Mukherjee acted with alacrity and went live on television to reassure investors and the markets that he would be able to deliver on the macroeconomic and fiscal goals he had set himself in his annual budget speech of March this year.

The Indian stock market indices had plummeted on hearing S&P’s negative outlook for India and regained only marginally after hearing the finance minister’s reassuring words. That more analysts and economists believe S&P rather than the Indian finance minister is just one more example of the credibility gap that has come to haunt UPA 2.

While Mukherjee and other government spokespersons,including the chairman of the prime minister’s economic advisory council,C. Rangarajan,have focused on the feasibility of attaining the budget’s fiscal targets and other macroeconomic goals,it is important to note that S&P focused not just on India’s deteriorating economic numbers but also on the prolonged political impasse that has gripped UPA 2.

S&P analyst Takahira Ogawa observed,“The outlook revision reflects our view of at least a one-in-three likelihood of a downgrade if the external position continues to deteriorate,growth prospects diminish or progress on fiscal reforms remains slow in a weakened political setting.” It is this “weakened” political setting that has once again come to haunt India.

While chief economic advisor Kaushik Basu was criticised for thinking aloud about the political constraints on economic policy,few took notice of the grave forebodings expressed in the presence of Prime Minister Manmohan Singh by an even more important functionary of the economic policymaking establishment,Reserve Bank of India Governor Duvvuri Subbarao,only a week earlier.

Speaking at a book release function in New Delhi,Subbarao reminded his audience that while in 1991 the fiscal debt to national income ratio was 7 per cent,this fiscal year it is expected to be 5.9 per cent,the current account deficit to national income ratio was 3 per cent in 1991 and is now upwards of 3.6 per cent,and the short-term debt to total external debt ratio was 10.2 per cent in 1991 and is now more than double at 23.3 per cent. While the governor reassured us that India’s many new strengths would prevent an economic “implosion”,he added for good measure: “Far from being complacent we should be agitated about the current state of the economy and about its prospects under a business as usual case… There is nothing inevitable about the India Growth story if the prospects of that promise materialising keep diminishing. We should prove that the current downturn is just a short-term phenomenon,and that the long-term growth drivers will come back into play.”

Interestingly,the RBI governor prefaced his remarks by posing the question,“Is 2012 like 1991?” and proceeded to argue that it need not be. However,Subbarao posed the wrong question,while drawing attention to only one dimension of the extant situation.

The correct question to be asked is whether 2012 could be like 1990 — the year of the gathering storm,the year before the crisis,the year when the downgrading began — first S&P,then Moody’s,then Japanese Bond Research Institute (JBRI),and then a repeat cycle of competitive downgrading.

Second,while Subbarao and other government spokespersons like Mukherjee and Rangarajan may all be right that the economy has what it takes to sail through a storm,the question remains whether the “political setting”,to use Ogawa’s phrase,would facilitate that or not.

It is important to remember that 1991 was not just an economic crisis. It was also the product of a political impasse.

The fiscal deficit and external debt numbers that pulled India’s sovereign credit rating down and created a panic among non-resident Indians,who withdrew their dollar savings in Indian bank accounts,was undoubtedly the product of several years of economic mismanagement. On top of this came the oil price spike following the first Gulf war in 1990. These events in themselves did not trigger off the balance of payments crisis.

What triggered off the crisis was panic generated by the belief that the government did not have the political capacity to act. When Moody’s and S&P downgraded India’s sovereign rating they gave equal weight to economic risk and political risk. Last year,S&P downgraded the United States more on account of political risk than just economic risk.

In 1990,the Chandra Shekhar government,and its finance minister,Yashwant Sinha,failed to get financial support from any of the G-7 economies or the International Monetary Fund (IMF). Sinha knocked on closed doors in Tokyo when he went seeking aid,and the then RBI deputy governor,C. Rangarajan,returned home empty-handed from a “secret visit” to the IMF,which refused to lend to a “minority” government with suspect numbers in Lok Sabha.

Prove that you are not a minority government,prove that you have the numbers to vote a pro-reform budget and then we will lend you money,the IMF told the Chandra Shekhar government. The government failed to do so.

In short,the crisis of 1990-91 was as much about a weak economy not being able to cope with external pressures as it was about a weak government not able to cope with domestic ones. Today,the economy is stronger,but the “political setting” does not appear to be so. Re-establishing the “credibility” of the government is key to averting an economic crisis.

After listening attentively to Subbarao,Prime Minister Singh said that while the economy is going through “difficult times” he was “confident (that) with great determination,we will overcome.” Was that a Freudian moment?

That phrase comes straight from Singh’s first budget speech of July 1991. Most remember the famous Victor Hugo quote in that speech,but few remember how that last paragraph ends: “No power on earth can stop an idea whose time has come. I suggest to this august House that the emergence of India as a major economic power in the world happens to be one such idea. Let the whole world hear it loud and clear. India is now wide awake. We shall prevail. We shall overcome.”

Stepping out of Parliament last week to face television cameras,Mukherjee echoed that very phrase: “we shall overcome”.

The writer is director for geo-economics and strategy,International Institute for Strategic Studies,and honorary senior fellow,Centre for Policy Research,express@expressindia.com

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