The initial reaction was one of shock and disbelief. Then, true to our nationalcharacter, vehement denial. Here we are, Asia's biggest emerging market and infotechpowerhouse, how can we be downgraded by a credit-rating agency like Standard and Poor's?Especially when Moody's has confirmed its positive outlook on India? Surely S&P's isover-reacting to a little fiscal slippage and industrial slowdown?
Is S&P's acting a little too propah by downgrading India's investment outlook frompositive in March to stable now? Let's look at some general numbers. The April-Juneindustrial growth rate has slipped to a pathetic 5.6 per cent compared to more than 10.5per cent notched during October-March. Could that be seasonal? Perhaps not, since even inthe first quarter of last fiscal, the Index of Industrial Production grew by 7 per cent.As for the little fiscal overkill, combined central and state fiscal deficit is again backat 10 per cent of the gdp. With $3 billion vanishing from forex reserves and externalinflows slowing down, the current account deficit is expected to double to $8 billion thisyear. Add to it the rising inflation, feared to touch 8 per cent, and the 66 per cent risein petrogoods prices in a single year, you could be staring at a potential harkback to thepre-reform era.
If S&P's rating surprised many in the government like RBI deputy governor Y.V.Reddy and finance minister Yashwant Sinha, it's just a matter of statistical quibbling.Sinha anyway called an industry bigwigs' meeting ahead of the release of the credit policyand summarily told them to prepare a blueprint for industrial revival in seven days. Reddysaid: "I was surprised by the rating because the main point raised is the fiscalsituation.... The first few months the fiscal situation has been encouraging and we haveindicated that we'd prefer to consider a reduction in borrowing for the currentyear."
He, however, is only partially right. The April-August fiscal deficit was Rs 36,447crore, down a quarter from the same period in fiscal 1999-2000. On the receipts side,however, the picture is opposite: against an expected disinvestment proceeds of Rs 10,000crore, the past six months have seen only Rs 233 crore slipping in.
And it's unlikely that we'll make up to stick to our deficit targets. More and moreeconomy-watchers are coming to the same conclusion and that also includes the RBI. In itsmid-term review of the monetary and credit policy, the RBI has continued with its policyof "cautious optimism" - that's RBI-speak for 'all's not lost yet' - andqualified its tone by saying that the outlook would have been grimmer but for the tamingof oil prices and the Millennium India Deposit Scheme turning the forex market sentimentfor the better. However, it has toned down its growth forecasts down from 6.5-7 per centin April to 6-6.5 per cent. It has also debunked the Centre's growth projection of 7 percent as impossible until "real investment growth occurs along with technologyimprovements and efficiency gains".
If RBI was prompted in part by the release of cso growth estimates in the first quarter(Q1) - 5.8 per cent compared to almost 7 per cent in Q1 of 1999-2000 - it's not the onlyone. The cmie has scaled its growth forecast from 7 per cent in July to only 5.8 per cent.And ncaer, which stuck to its 7 per cent forecast as recently as in August despiteworrying trends in industry and BoP situation, is now speaking of 6. 4 per cent.
Why did we have such a great fall? Most likely because we were sitting on the wall forfar too long. It's just a set of old problems that are crying out for new and drasticsolutions. The voice of the industry is clear in the CII president Arun Bharat Ram's notefor the FM meeting which says: "The biggest problem is the state of manufacturing.Uneconomic cost of capital, high cost and low quality of power, lack of flexibility in useof labour, poor infrastructure facilities and large-scale dumping by China which will growenormously in the near future." Or in K.. Memani, partner, consultancy major Ernst& Young, who avers: "Industry is sitting on a lot of capacity but with demandgrowth flat, rising costs and stagnant prices for products, there is not much it can do.This has led to a sudden slowdown. As for investment in infrastructure, it's achicken-and-egg situation."
Memani is bang on target. How long can industry and economy go on withoutinfrastructure development? Says Sanjiv Goenka, VP, CII: "Some 29 sectors have shownvery high negative growth in the second half and most of these are infrastructure andinfrastructure-related areas - power, capital goods, pharma, automobiles, telecom cables,etc." Here neither foreign nor domestic private investment is coming in. Becausedomestic industry is not competitive or credit-worthy enough to sink in huge funds andforeign investors are either getting discouraged by procedural bottlenecks or arepreferring to wait and watch as states continue to practise populism.
S.P. Gupta, member, Planning Commission, put it succinctly: "There's a huge gapbetween reform and perform. We seem to be doing a lot of the former, but not following itup with action. Now even the services sector is slowing down because the class of peopleit had benefited has a high elasticity of demand for consumer goods and that'ssaturated." Let's look at ground realities:
- Power reforms started eight years ago but is still mostly on paper except for a couple of distribution companies in Orissa and a lot of heartache in Andhra and UP. But costs are going up, especially for industry as initial reforms have meant a steep hike in tariffs in states.
- Software exports alone cannot achieve dramatic growth rise until manufacturing growth picks up. That is, firms achieve economies of scale and become competitive. Which they can't do because India still is a high-cost economy.
- Some say if the old economy is dying, let it. But are enough new enterprises taking its place? No. Thanks to a rigid financial sector, populated by battle-scarred banks and inflexible interest rates, lack of policy to encourage small and medium enterprises, and a capital market that's naturally reluctant to rev up.
- No farm sector reforms yet. This year, the rain god has been a little unkind and we're back to 1.3 per cent growth forecast, compared to 4.2 per cent forecast earlier. With agricultural incomes still key to a rise in overall consumer demand, neglecting reforms in this sector is suicidal.
- The government continues to be slothful, huge and bureaucratic. No downsizing, no respect for cost-cutting, no agreement on big-ticket reforms like privatisation (soft-pedalling for a decade now), insurance, opening up of infrastructure sectors like water and housing to foreigners.
The government can do a lot, assuming it wants to. For instance, start privatisationand small-scale dereservation, clear a few big infrastructure projects and give fillip toconstruction, allow a few power producers in without curbs, raise farm power tariff,change labour laws and downsize. It, however, might end up doing little: a few concessionsand make some imports tougher.
Says Bernard Pasquier, South Asia director of ifc, World Bank's private investment arm:"We don't think a little slowdown could affect our long-term outlook on India, whichremains very bullish for the long run. But then, a crisis usually goads a government intodoing a lot of unpalatable but desirable things." Agrees Rajiv Vij, Templeton Indiahead: "Despite the feel-good factor disappearing, I don't think it changes thelong-term potential of this country. I hope now the government becomes proactive onprivatisation."
Can we end on a note of hope? Only if, as Vij says, this serves as "a wake-upcall, to turn our potential into reality. I see the pessimism continuing till thegovernment takes some big steps to unlock value." The structural limitations in theeconomy will not go away without a big shake-up. And if the government shies away from it,it will lose the one chance in a millennium to put India up there in the global ranking ofnations.
