The major concerns of the rating agency appear to be growth prospects and the state of the external and fiscal accounts, which is quite normal for any country rating. The first question to be asked is whether conditions have changed drastically or even marginally in the recent past. The answer is no. The economy appears to be on the growth path of 7-7.5%, which, though lower by our own past standards, is definitely impressive compared with that of other nations. Can this growth rate be sustained in the coming year The answer appears to be yes, as monetary policy has already taken a marginally positive turn and inflation appears to have come down, though there could be pressure from oil prices, which is a global phenomenon. One must remember that growth has come about through strong performance of the service sector supported by farm output. This has made up for the lower industrial output. Even the IMF, in its World Economic Outlook, looks at stable growth in 2012 with a marginal improvement in 2013.
The external account is a concern, given that the current account deficit has been widening. However, it must be pointed out that the main reason for this has been the high growth in the import bill on account of fuel and gold. The latter has slowed down, while crude oil would remain an unknown quantity. Quite heartening has been the strong growth in exports of $300 billion in FY12 through country-diversification. Remittances and software have continued to provide strength even at a time when the euro region has been on a downward path. Hence, while the current account deficit would still be under pressure in the range of 3-3.5% of GDP, it is certainly not in a crisis-like situation. More importantly, the strong FDI inflows and liberalisation of ECB norms has provided strong capital account support even when FII flows have slowed down.
The fiscal issues must be bifurcated. The first is that these pressures are existing ones and not new developments. While controlling subsides and attaining the fiscal deficit targets would be a challenge, the government has targeted a more realistic number this year, which could be achieved, given the steps that are being taken to garner revenue. The subsidy bill would, however, be something to be monitored, though the cooling of oil prices could provide comfort.
The second is that while fiscal deficits need to be controlled, the ultimate test for their impact is on debt and liquidity. Here, it can be positively stated that our debt-to-GDP ratio is very low, at around 45%, unlike the western nations in difficulty, where it ranges from 80-120%. Further, debt is in local currency and poses no systemic risk to the global economy. The impact on liquidity has been perceptible, but to the credit of RBI, it has handled it adeptly throughout the year through OMOs and CRR reduction to ensure that liquidity did not come in the way of private sector being crowded out. Therefore, once again while the situation is serious, it has not exactly had a deleterious impact to generate panic. More importantly, the banking system is very well capitalised and while NPAs may have increased in FY12, they are within the global norms of 1-1.5%.
The concerns on certain policies like GAAR and retrospective taxation are issues that are still at the discussion stage with the government. While they could impact investment decisions at the margin, it should be remembered that investment to any nation moves on the promise of long-term growth. Improper implementation of such policies could be a deterrent but the government has assured investors that there would be selective use of GAAR. The response of foreign investors since the proposal was mooted appears to be cautious but we have not observed withdrawal from the market. Other reforms or policy changes, while being possible stimulants, cannot really be used as a reason for change of outlook, considering that we never had these reforms in place all these years.
What would be the impact of such a change in outlook Practically speaking, any lower rating or outlook affects companies that are borrowing in the euro markets. This will become an issue in case the rating is actually altered. However, at the broader level, the impact on investment would be mixed. The present concern on GAAR has slowed down FII flows. However, they will be guided more by long-term prospects, which even the rating agency admits are favourable. If investors see the growth story to be interesting, then funds will flow in. We probably should leverage this situation, get our act together and bring clarity to these new proposals with some urgency, and also hasten the pace of reforms.
Therefore, on the whole, the change of rating outlook should be viewed against the background of strong fundamentals and relative performance vis--vis other nations. The macro impact should not be too serious as we have seen this happen to several nations in the last year, which has not really significantly changed global capital flows or reputations.
The author is chief economist, CARE Ratings. These are his personal views