Junk debt - or a rubbish rating? By Kunal Kumar Kundu
BANGALORE - United States-based rating firm Standard & Poor's downgraded
its outlook for India's sovereign debt from stable to negative on February 24,
while retaining the country's BBB- rating - the lowest investment grade. In
essence, India's sovereign debt is just a step away from being declared junk.
Not only does that indicate that the economy is in a perilous state - it drives
up the cost of borrowing.
The last time India was downgraded to junk was in 1991. Are we saying that
India is currently on the edge of the precipice and is about to hurtle down the
abyss, as it did then, when, if memory serves me right, inflation ruled at
16.7% in August 1991. India's foreign currency assets were worth a measly
US$1.1 billion on
June 30, 1991, just good enough to cover the country's import bill for a
fortnight.
That year, the government leased 20 tonnes of gold to the State Bank of India
(SBI) for sale abroad, with an option to repurchase it after six months. The
government also asked the Reserve Bank of India (RBI) in July 1991, to ship 47
tonnes of gold to the Bank of England to raise $600 million.
Agreed, India's current fiscal situation is a cause for concern. This is
purported to be the background for the current downgrade, along with external
vulnerability, given the rising current account deficit. But before we go into
the depth of the issue, it is important remember that in the interim, during
2001-2004, there was a strong debate on same issue, when global rating agencies
downgraded India in view of a rising fiscal deficit.
In January 2004, Professor Nouriel Roubini (RGE Monitor) and Richard Hemming
(senior advisor at the Fiscal Affairs Department of the International Monetary
Fund) in their paper "A Balance Sheet Crisis in India?", drawing on their and
India's experience of the previous crisis in 1991, concluded by highlighting
several vulnerabilities that India was on the verge of another crisis. In
retrospect, however, these risks never materialized. India recorded 8%-plus
annual gross domestic product (GDP) growth for the next few years thereafter
and everything was under control.
Now, the specter of a high deficit is again looming large. India's estimated
fiscal deficit for the financial year 2008-09 is 6%, and if one takes into
account the state government deficits, the total fiscal deficit should be in
the region on 9% to 10%. However, the uptick in the deficit has as much to do
with rising expenditure as it has to do with falling revenues as growth
momentum slows, following the contagion effect of the global crisis.
It is important to note that the fiscal deficit rose despite a sharp fall in
private spending. Hence the rise in the fiscal deficit has not been caused by
private spending. Even the external (im)balance that is of concern to the
rating agency has a lot to do with the global financial crisis. In fact, with
domestic demand shrinking and commodity prices falling (and unlikely to improve
much even next year or the next given the general recessionary trend), India's
external balance will be much under control going forward.
Given the demand contraction (both domestic and external), India will be lucky
to record even 6% GDP growth in 2008-09. It is not expected to be much better
than 6.5% even by 2009-10. Thereafter, India will record much higher GDP
growth. Clearly the fiscal vulnerability that is being talked about is more
cyclical than structural and hence is a lesser cause for worry.
Seemingly, for the the rating agency economists, these are issues not important
enough to dwell on, and hence they have decided to sound alarm bells by simply
going by the macro-indicators and their past experience, failing to take
congniscance of the fact that the business environment changes and a much more
holistic view needs to be taken.
In the case of India, 1991 was different. Since then, India has seen many
structural changes and, as an economy, the country is in a much better shape.
Because of prudent practices, India has managed to avoid the financial
contagion that many developed economies, with their cutting-edge policies and
regulations, have fallen into.
A major part of the blame for the implosion of the global financial market has
to do to with the credit rating agencies themselves, for their miserable
failure to predict a crisis that was possibly one of the most predictable ever
to hit the global financial system. Agencies that pour their energies into
studying company data day in and day out could not predict the collapse of the
US housing bubble, despite every data indicating that big trouble was brewing.
Not only that, they went ahead and boldly gave a high investment grade rating
to various structured products that abounded with junk, leading to the problem
being exacerbated.
A scorecard released recently by Credit Suisse detailing the vulnerability of
various countries repays study. (Click here for table.)
Credit Suisse ranked countries with regard to their vulnerability by taking
into account various factors, the lowest ranking being more vulnerable. The
table highlights the ratings given to the East European countries. As we all
know, this region has the ability to have a severe impact on even the developed
European economies. The S&P rating column shows that only one East European
country, Latvia, had a BBB- rating similar to that of India. All others have
higher rating than that of India, at times substantially higher.
Yet consider that fact that Hungary, Ukraine and Romania have already gone to
the International Monetary Fund (IMF) for a bailout. In contrast, India is
talking of making contributions to the IMF's coffers to finance these bailouts.
India's ranking is 25, that is, it is a country considered to be much less
vulnerable than others. More importantly, consider Iceland, now a poster boy of
doom because of its reckless policies. Iceland was rated similarly to India.
Clearly, S&P even failed to predict Iceland's tremendous fall from grace.
Given the current situation, Keynesianism - with government spending seeking to
take up the slump in the private sector - is the way out of the present crisis
for most countries. Given the contraction in domestic demand, India needs to do
the same.
Similarly for the US. The forecast fiscal deficit for the US in the current
year is higher than that of even India. It is quite likely that, if S&P or
another such rating agencies were handed the relevant data for the US without
the information to which country it referred, the sovereign rating that would
result for the world's biggest economy could well be "junk".
Kunal Kumar Kundu, a former senior economist with a leading bilateral
chamber of commerce in India, now works with the Knowledge Service Division of
Infosys BPO Ltd. He has a Masters in Economics with specialization in
econometrics from the University of Calcutta. The author here is expressing his
personal views.
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