Last week, Moody?s raised India?s foreign currency rating to Ba1 with stable outlook. The rating on domestic debt remained a notch lower at Ba2 and with negative outlook. India joins company with Japan, the only other country with domestic ratings lower than external ratings. Thus, our situation far from being the rule, is the exception. For those who find the circumstance counter-intuitive, think back 12 years. To that pathetic state in 1991, when we shipped gold to London to meet our external debt service obligations; to the adverse trade balances, poor service and foreign investment prospects and terrible business confidence. And then return to today?s comfortable trade balances, large and growing service sector exports, stable remittances, enhanced foreign investment and a pile of foreign currency reserves that is seventh largest in the world? after Japan, China, Taiwan, South Korea, Hong Kong and Singapore. By contrast, our fiscal affairs after improving to the mid-1990s, have just drifted, and drift in policy and governance means retrogression. The combined fiscal deficit of government (including electricity boards) was 9 per cent of gross domestic product (GDP) in 1991, but tops the scale today at 11 per cent. Further, in 1991 the revenue deficit was 40 per cent of the fiscal deficit. Now uncovered revenue expenditure constitutes 67 per cent of the fiscal deficit. So, while reforming India has made considerable advances in most areas with favourable consequences on external balances, it has by stubborn foot dragging on fiscal reforms, created unpleasant debt arithmetic.

Following on the rating change, criticism of ratings per se has been in some evidence. One, that sovereign ratings have not been a good predictor of currency crisis, basically a reference to Asian difficulties in 1997-98. The principal problem of the ?Asian miracle? was regulatory weakness, with large gaps in what the central banks knew about the external liabilities of their domestic banks, and rating agencies were affected by the same information lapses. Second, till this crisis, mainstream economic theory, had oversimplified the process by which capital flows occur. The received wisdom in the mid-nineties had little space for the singularity of large currency crises and contagion.

The second strand of criticism is more proximate. It argues that government cannot default on public debt held by domestic players. Now, there is a line of thinking beginning from the classical economist David Ricardo, made contemporary by Robert Barro, that government bonds do not represent net wealth, since people are saving today in anticipation of higher taxes tomorrow ? the inevitability of deficits. The empirical evidence, slender as it is, does not show Ricardian Equivalence at work in real life, although were it to work, goodbye the fiscal multiplier.

The critique of rating agencies was however mounted by a champion of the multiplier. So the contention that default to domestic sovereign debt holders is not possible must be taken to literally mean just that. Inconveniently history is replete with crowned heads of Europe who took their debtors to court and ruined them. An interesting parallel has been drawn between domestically held public debt and equity. Governments can indeed emulate lousy corporate managers, who run their companies badly, accumulate losses and then charge them off against net worth. We know what markets think of such companies. Lesser sovereigns have throughout history debased their currencies. The modern equivalent is to print notes and stoke inflation, combined perhaps with pre-emption of bank deposits and other instruments of financial repression.

High inflation has another side effect: it does not reduce real incomes of the propertied, only of those with fixed incomes. The latter are thus effectively taxed to pay off the public debt contracted in earlier years. The practice under circumstances of corporate default is to write down some of the debt?a mirror image of what high inflation permits governments to do. It is always a temptation to listen to siren songs and the end is as unhappy as for the straying sailor. Just as responsible emperors never debased their currencies, great economies are built on the firm foundations of monetary and financial stability. Fiscal consolidation has drifted for too long; it has cost us dearly and a more purposive course must be struck.

The author is economic advisor to ICRA (Investment Information and Credit Rating Agency)