Political mismanagement in an economy that's structurally weak: Moody's swings is all you get
I must admit to a feeling of quiet satisfaction in correctly predicting a "do nothing" budget. Not a dif-ficult task for a political economist, but still.... Hopefully, some people will realise that it pays to start listening to young minds and not tired old men.
The consequences of my being correct are dire, again in a political economy sense. Get used to the idea that the ministry of finance has run out of intelligence, analysis, and initiative. The finance minister himself admitted as much. In Bombay, he said that he "was surprised" at Moody's downgrading and the market reaction. So, our finance ministry now cannot anticipate even the most predictable events. Despite the presence of a chief economic advisor, various other professional underlings, a technocrat finance secretary and of course, the IAS—our modern, technically competent 21st century civil service (dream away)—the FM is "surprised". Clearly these worthies have not grasped the first principle of political economy—that political credibility involves not shooting your mouth off, and presenting a policy picture that does not contradict publicly observable facts. For many years, Indian policy-makers successfully avoided doing this. Not any more, clearly.
The Moody's downgrade happened because of four facts, all of which are in the public domain. First, as I have repeatedly stressed, the Indian economy is structurally insolvent. Government spends more than it raises by way of revenue and borrows to fill the gap. This type of borrowing increases public debt without generating a flow of resources to pay it back unlike borrowing to finance investments which yield returns. Second, India's balance of payments is also structurally insolvent. India imports more than it exports and relies heavily on foreign borrowing to fund the gap. With these two facts a part of the economic scenario, our "investment grade" credit rating is permanently in jeopardy.
The third fact that recently emerged was that India decided to display nuclear virility. This conspicuous display of political insecurity, with its attendant financial consequences, pointed to a government not in control of its political fortunes, dangerous in a situation of potential economic insolvency. Fourth, a lacklustre budget, with a sharp increase in defence spending, thereby causing a rise in the revenue deficit. No prospect of increasing tax revenues to fund the gap.
Add to these facts, a domestic private sector marked by short-termism and poor corporate governance, a stockmarket dominated by a handful of companies and obsessed with windfall gains, and one of the worst global track records in converting foreign investment proposals into actual projects and what do you get? Not a triple 'A' investment rating, Finance Minister, that only happens in saffron-cloud-cuckoo land.
Yashwant Sinha seems to think that Moody's ratings were influenced by the Southeast Asian crisis. Not true, except to the extent that Southeast Asia is now more competitive vis-a-vis India than it used to be. In fact the opposite should be true. Given the Japanese recession, the fact that investors are scared to put their money in Southeast Asia, and the much higher rates of return available in India compared to Europe and the US, foreign investors should be interested in putting money into India. The global finan-cial markets would be willing to lend to good Indian companies with a strong investment track record, if there were enough such companies, and if India was able to demonstrate the will to overcome its structural constraints. Note that the Power Finance Corporation comfortably managed to raise money in London, after the nuclear crisis. But India is one of the world's poorest countries, and domestic companies with a good track record are all too few.
The major financial impact of the downgrading is simply that it becomes more expensive for both government and the private sector to borrow money in the international markets. Does this matter? A downgrading in credit risk raises the rate of interest charged on borrowing. Therefore, it is now more expensive to borrow abroad. But it is certainly not the case, either in London, or on Wall Street, that lending to India is unacceptable. All it means is that instead of borrowing at around 8 per cent, Indian companies will now borrow at around 11-12 per cent, and government at 9-10 per cent.
This is still cheaper than borrowing at home, both for companies (who borrow at at least 16 per cent) or government (10-12 per cent). The major problem, of course, is devaluation. Loans in foreign currency have to be paid back in foreign currency. Devaluation means that more rupees have to be paid in for every dollar borrowed. And this is where our unstable macro-economic situation comes home to roost. As long as the fiscal and trade deficits remain structurally unsound, the rupee gets weaker and weaker. As the rupee gets weaker, government borrowing becomes more expensive, raising the revenue deficit. And the trade gap is widening. Already, the London markets predict an 8 per cent slide in the rupee over the next six months.
This process should be self-correcting. Devaluation makes exports cheaper. The trouble is: What do we export? Indian companies are not exporters, they borrow abroad and make money in the domestic market. Few Indian companies are internationally competitive. Prospects for sharply increasing agricultural exports are limited. Hence, devaluation is not beneficial but potentially dangerous. In such a situation careful political management is vital. Our current problems will recur again and again and again, until steps are taken to remedy the basic structural weaknesses in the Indian economy—in both the public and the private sectors. As I have pointed out previously, real virility comes from a strong economy and sustained growth. Otherwise, nuclear and military posturing are like our Indian weddings—lavish and fun when they happen but crippling in their impact on the household's debt and economic fortunes. But how do you expect a 'Hindu' government to understand that?