Why Everyone Is Freaking Out About India

indian woman construction, labour, poverty

Photo: Daniel Berehulak/Getty Images

India’s GDP slowed to 5.3 per cent in the January to March quarter. Since then S&P has warned that the country could lose its investment grade, and Fitch revised India’s outlook to ‘negative’.Sentiment has turned against India not just on a slew of weak economic data, but also the country’s political unwillingness to implement reforms, and on allegations of corruption.

We drew on S&P’s report, “Will India Be The First BRIC Fallen Angel?” for a broader look at what’s got everyone bothered about the Indian economy.

While S&P says the country is in a better position to deal with economic shocks now than it was in the past, the country has many challenges ahead.

India has the lowest credit rating among the four BRICs

India has the lowest credit rating among the four BRIC nations, and it is the only one with a negative outlook. Russia and Brazil have 'BBB' long-term foreign currency ratings, China has an 'AA-' rating, and all three have stable outlooks.

Meanwhile, S&P has India's long-term sovereign rating at 'BBB-' but with a negative outlook, meaning there is a one-in-three chance of a downgrade in the next two years. S&P has warned that India could be downgraded to junk status.

Source: Standard & Poor's

Business confidence has taken a hit

Business confidence in the country has taken a hit for a host of reasons including 'policy paralysis within the central government'.

The perceived slowdown in government decision-making, failure to implement reforms that have been announced, bottlenecks in crucial sectors have all contributed to the deteriorating business confidence.

Set backs in economic policy, for instance the reversal in the cap on foreign direct investment (FDI) and government's stance on retrospective taxes, have hurt investor sentiment.

Source: Standard & Poor's

Lower savings rate in coming years could translate to lower growth

India's economy grew about 8 - 9 per cent in the three years preceding the global financial crisis. But GDP is expected to grow about 6.5 per cent in FY 2012-2013.

Fiscal strain and lower corporate profits are reducing both public and private sector savings rates in coming years which could lower investment and raise the current account deficit. This in turn could lower GDP growth or raise the external deficit making the country more vulnerable to external shocks.

Source: Standard & Poor's

The momentum for economic reform has stalled in recent years

Senior Indian policymakers say they are committed to liberalizing the economy and pushing a market-oriented growth strategy. But the momentum for economic reform has slowed recently.

There is real concern that in trying to curb India's external deficit, its policymakers may shift policies to favour domestic producers.

Source: Standard & Poor's

And there is even a risk that India's economic liberalization could recede

'Indian officials have consistently stated that while economic reform may be slow because of the political realities of a largely poor, diverse, and democratic country, it could only go forward. But is there a risk that economic liberalization may not just stall, but could even recede?

Such a retreat might be in line with the more interventionist economic policies many developed countries pursued in response to the recent global economic crisis. However, India's economic conditions differ greatly from those of developed countries, and its economic performance has been remarkably successful since liberalization began. Failure to advance with more liberalization might reduce India's long-term growth potential and thus hurt its sovereign rating.'

Source: Standard & Poor's

Perception of poor political governance is rising and could undermine reform

Recent political scandals involving government corruption charges has increased public perception of poor governance. The government has been named in mining, telecommunications, oil and gas, and land acquisition scams and this could impact public support for pro-market policies.

'Practices that in many instances are favourable for business, especially politically well-connected firms, are often misinterpreted in general public opinion as being pro-market, rather than pro-business. Hence, public backlash against such abuses may erroneously result in a backlash against market-oriented policies.'

Source: Standard & Poor's

And there is a risk that policymakers will turn to populist policies

There is a risk that Indian policymakers could boost public spending on services without any real reform, or tighten regulations and create a bigger burden on the private sector.

Heavily regulated sectors like energy, mining, infrastructure and financial services are more vulnerable to such risks.

Increased government revenues have in the past gone towards subsidizing consumption and increases in public-sector salaries, all of which is considered to be misguided and which tends to skip the very poor who need it the most.

Policymakers might be especially tempted to go this route if economic growth were to slow more than expected and seriously reduce the pace of job creation.

Source: Standard & Poor's

Reforms have been delayed because of political impasse

The risks around India's economic policy stem from its politics, since all legislation has to pass through both houses of parliament.

The current Congress-let coalition has failed to push through reforms because of 'internal strife, uncooperative coalition allies, and an obstructionist opposition.'

What's more? The Bharatiya Janta Party (BJP), the leading opposition party, is criticised for opposing reforms like raising caps on FDI in multi-brand retail, pension reform, and privatization, all of which it had first introduced, for the sake of being partisan.

Source: Standard & Poor's

Divided leadership at the centre is the biggest problem

Political power lies with Congress party leader Sonia Gandhi, who has appointed cabinet members but doesn't have a cabinet position herself. Meanwhile, the government is lef by Manmohan Singh, an unelected prime minister without his own political base:

'Hence, the prime minister often appears to have limited ability to influence his cabinet colleagues and proceed with the liberalization policies he favours (and constantly advocates in his public speeches). For example, Singh has been unable to liberalize the heavily controlled coal sector despite publicly advocating it for many years.'

Moreover many senior Congress leaders oppose economic liberalization because they it would cause them to lose power over regulated sectors of the economy or worse, because 'economic reforms will cost them votes, or at least will not gain new votes.'

Source: Standard & Poor's

India's credit rating could be downgraded if it doesn't curb current spending and if weak GDP growth causes revenue shortfalls

'Under a more pessimistic scenario, political problems could prevent the government from containing the growth in current spending, and lower-than-projected GDP growth could result in revenue shortfalls.

Politically inspired spending programs could further widen the fiscal deficit. Lack of progress in alleviating bottlenecks in key sectors of the economy could lower both domestic and foreign investment levels. Fiscal slippage, combined with persistently high inflation, could further weaken investor confidence.

Both the government's debt burden and fiscal flexibility could continue to erode, in step with rising external vulnerability because of higher trade and current account deficits. India's credit quality would suffer under such a scenario, and a downgrade could result.'

Source: Standard & Poor's

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