After the plethora of good news on the economy, ranging from an improvement in the doing-business rankings to becoming the world’s most preferred destination when it comes to FDI, credit rating agency S&P refusing to change India’s rating from just above junk comes as a bit of a rude wake-up call. Look at it a bit deeper, and the S&P move doesn’t come as that much of a surprise. While much of the improved macro comes from purely good luck on the commodity front, the collapse of China has been the main reason for the upswing in FDI rankings—indeed, the boom in FDI comes at a time when local investment levels are at unusually low levels of 28.7% of GDP versus a high of 38% in FY08. A good way to understand this is to examine how India’s inflation and current account deficits (CAD)—the two biggest turnaround factors in the macro, along with the rupee that is directly related to both—would have looked if global commodity prices, including gold, had not turned around in the last couple of years. In just the last one year, despite exports collapsing from $81.7 billion in Q1FY15 to $68 billion in Q1FY16, India’s CAD has still fallen from 1.6% of GDP to 1.2%—it was 4.8% in Q1FY14.
Perhaps the single-biggest reason for this is the collapse in the price of oil. Between FY14 and FY15, as a result of this, while oil imports collapsed from $164 billion to $138 billion, exports fell from $63 billion to $57 billion, or a net gain of $20 billion. Just that difference would have made the CAD rise by around 1% of GDP, a figure which would have made India’s macros look a lot less attractive considering the sharp fall in non-oil exports in the last year. A high crude price, in turn, would have pressured both inflation as well as the fiscal deficit. In the case of gold, the real difference can be seen over a two-year period—imports fell from $16.5 billion in Q1FY14 to $7.1 billion in Q1FY15 and rose slightly to $7.5 billion in Q1FY16, or from 3.6% of GDP in Q1FY14 to 1.5% of GDP in both FY15 and FY16—once again, the collapse in global gold prices is a matter of luck, not the result of the Indian government’s policy.
Contrast this with the problem areas that S&P details. A fiscal deficit that is under control, but leaves India no room for any counter-cyclical expenditure—indeed, with interest payments eating up 31% of gross tax receipts and just under half of net revenues, the fiscal deficit is still a problem. As S&P puts it, at 19.5% of GDP, India’s consolidated tax revenues are in consonance with poorly-rated countries while, at 2% of GDP, the subsidies are quite considerable. Add to this the likely strain of the one-rank-one-pension and the pay commission and the cost of the likely bank recapitalisation—$35 billion over 3 years is what S&P estimates, though the government share could come down to the extent banks can raise funds from the market. It doesn’t help that the government is cash-strapped at the time when it most needs to spend more money to take up the slack for the corporate sector whose balance sheets are too strained to invest aggressively. In other words, the Indian economy is still work-in-progress and any slippage, due to a hike in oil prices or investment not picking up—among a host of others—could just as quickly endanger its stability.