Standard & Poor?s has stated the obvious by bumping up the Indian outlook to stable from negative. After the financial contagion subsided, leaving few economies standing in the global ruin, even the most cussed investor would need to do little more than just glance around her to confirm that.
In the present world it would have looked bizarre if the negative outlook had continued. For this would have meant one of the most promising investment directions for the global investor community is one with a negative story. Among all the topsy-turvy tales emerging from the global meltdown this one would have ranked at the top.
The tale that will, however, be told is the one about the crazy fiscal deficit that India keeps running without choking off its economic growth rate. The upgrade in outlook makes the right noises about the need to keep this deficit in check, but the S&P report has come perilously close to endorsing the position that fiscal deficit is good for the economy, if an economy knows how to use it.
This is quite close to overturning conventional economic wisdom. The fiscal deficit in India has persisted through the industrial downturn since 1997, has stayed put in the heady growth years and has now returned with a ?bang? to provide stimulus to the economy. Yet at no stage have the numbers threatened to derail the rate of economic growth of the economy.
Why has this panned out in this way? In the early years of the Indian development story, economists worked out a two-gap model to describe India?s needs. Of the two gaps, one was the shortage of technology that needed to be bought from abroad. The other was the shortage of foreign capital needed to finance those buys. The logic of that gap theory has altered in the post-liberalisation era. It can now be called a single gap model predicated on a domestic engine of growth instead of a foreign one. The engine is government expenditure, needed to run a deficit to finance the consumption needs of the people, which, in turn, drive production in the private sector. We have seen the application of that logic in the NREG scheme, the debt waiver scheme and recently in the excise duty relief that has created a wave-like transformation in the automobile sector, especially in the passenger car segment.
From financing consumption needs, the deficit is now turning to finance the investment needs of the economy. The economy, therefore, has built in an absorption capacity for the fiscal deficit, of course with a lag and a degree of consequent wastage that this sort of model implies. So, the fiscal deficit in India makes up for the shortage of demand that a developing economy is prone to.
In fact, the government by trial and error has learnt to be fairly flexible with the application of the deficit. Instead of building up capacity in the same direction, over the past decade it has learnt to move it around to where the economy needs it the most.
So, far from being a gridiron lock for the economy to sort out, the deficit has more often than not been the answer to the demands of the economy. The changed outlook by S&P and also by other rating agencies, therefore, adjusts their conservative stance with the reality of an economy that is behaving quite differently from the textbooks.
Of course, there is a rider here. The Indian government has been able to do this Houdini trick because it also owns 70% of the domestic banking sector. Government borrowing is, therefore, secured by a compliant banking sector. Despite that comfort, the cost of the high deficit has hit these banks hard in 2009-10. As the growth story progresses into the next decade, these collateral damages could mount.
On an immediate note, the change in outlook has a happy consequence. The changes in ratings or outlook essentially guide the debt market by altering the rates for loans raised by the entities involved?either the governments or the companies.
But India has not borrowed from the global markets for more than half a century. The closest it came were the three bank-led deposit drives from NRIs in the nineties and early 2000s.
That story might change soon. In Budget 2010-11, the finance ministry proposed to raise Rs 34,735 crore (gross) or $8 billion, from external agencies. This is no chicken feed. It is 25% more than the sum earmarked for the current year.
The change in outlook will take off a few basis points from the rate at which the government will contract the loans. Of course, a large percentage of the loans will come from the World Bank and some more from the ADB. The former, in any case, offers the loans at very low rates, so the government is in a very safe position. But at a time when the cost of servicing the interest on total loans is 36.4% of the total revenue receipts of the government, the shaving off in the rates will help in managing the deficit. So, while analysts may say the change in the ratings outlook for India just follows the market wisdom, there is enough scope in the upgrade for the government to cut its fiscal deficit.
?subhomoy.bhattacharjee@expressindia.com