India: Top Dog In the Long-Run … Economic Crisis In the Short-Run

The First BRIC to be Downgraded to Junk?

India is currently one of the world’s biggest economies, ahead of Spain. Both the CIA and World Bank have India as the 9th largest economy, and Spain as the 12th.

India is forecast to be the world’s third largest economy by 2030, and the world’s number 1 economy by 2050 (the same year that India will become the world’s most populous country).

And because India’s age demographic is so young, the costs of supporting its elderly is incredibly low:

Graphic Courtesy of CreditWritedowns.com. Data from http://data.un.org/

So things look bullish and rosy for India, right?  Long-term, yes.

Crisis In the Short-Term

But in the short-term, India has big problems.

S&P has just threatened to downgrade India to junk.  The Telegraph notes:

The rupee weakened and shares tumbled after Standard & Poor’s warned that a slowdown in economic growth and the political paralysis on economic development gripping the country carried the risk of re-rating.

Currently India’s BBB- rating is just one level above junk status and the lowest in the Bric ‘club’ which has Brazil, Russia and China as its other members.

Joydeep Mukherji, a New York-based S&P analyst, said: “Setbacks or reversals in India’s path toward a more liberal economy could hurt its long-term growth prospects and therefore its credit quality.”

Growth in the booming Indian economy has slowed with the loss of export business in depressed European markets while business leaders are deadlocked with the Government over economic development plans and policy changes. Corruption scandals have not helped India’s image while some foreign investors say they now get a cooler reception.

India has a record trade deficit, the biggest among the Bric nations, and an inflation rate of more than 7pc but prime minister Manmohan Singh has promised to stimulate the economy with port, road and power plant projects.

The Times of India reports:

International rating agency Standard & Poor’s (S&P) has warned that India risks a sovereign downgrade which would result in the country dropping off the list of countries with an investment-grade rating.

The statement comes less then two months after the agency revised the outlook on India’s rating to negative from stable and said that the country has a one-in-three chances of being downgraded in the next two years. India presently enjoys a BBB- which is the lowest investment grade rating.

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The trigger for the recent report appears to be the sharp drop in India’s quarterly GDP growth numbers and the drop in the value of the rupee.

“In our view, setbacks or reversals in India’s path toward a more liberal economy could hurt its long-term growth prospects and, thus, its credit quality. How India’s government reacts to potentially slower growth and greater vulnerability to economic shocks may determine, in large part, whether the country can maintain its investment-grade rating, or become the first “fallen angel” among the BRIC nations (which include Brazil, Russia, India, and China),” it said.

According to S&P, business confidence has been undermined by a perceived slowdown in government decision-making, failure to implement announced reforms, and growing bottlenecks in key sectors (including lack of reforms to archaic land acquisition laws that hinder investment). And, infrastructure problems, combined with growing shortfalls in the production of coal and other fuels, have dampened investment prospects.

“For example, various regulatory and other obstacles have delayed a proposed $12-billion investment in the steel sector by Korean steelmaker POSCO–potentially the biggest foreign investment project in Indian history–by more than seven years. Other steel projects have also faced extensive delays because of land acquisition hurdles and other issues,” S&P said.

The rating agency is concerned about recent setbacks in economic policy which have hurt investor sentiment.

“Strong opposition from within the Congress party-led ruling coalition, as well as from opposition parties, recently forced the government to reverse its decision to raise the cap on foreign direct investment (FDI) in multibrand retail to 49% of total ownership from 26%. Similarly, pressure from a coalition ally of the governing Congress party caused the government to roll back a 10% hike in passenger train fares and forced the Railway Minister to quit. (Passenger fares have been flat for many years despite substantial growth in personal income and high inflation.),” S&P said.

The rating agency has said that in a pessimistic scenario there is a risk that 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,” the rating agency said.

The Times of India warned in December:

India may face its worst financial crisis in decades if it fails to stem a slide in the rupee, leaving the Reserve Bank of India (RBI) with a difficult choice over how to make best use of its limited reserves to maintain the confidence of foreign investors.

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Unlike most of its Asian peers, India has recently been running large current account and fiscal deficits. That means it must attract sufficient foreign money — namely US dollars — to close the gap, and a weaker home currency makes that costlier.

This is a perennial problem for India. The current situation is so worrisome because India is grappling with big internal and external economic threats simultaneously. Growth is slowing. Inflation remains high. Political paralysis has stymied domestic reforms.

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Beyond India’s borders, Europe is the biggest worry. As its banks deleverage, investment money has flooded out of India’s markets. If Europe’s debt troubles deteriorate, India could be hit with a balance of payments crisis as severe as the one that forced a sharp devaluation in 1991.

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If Europe’s crisis deepens, India’s trade deficit would widen even more rapidly, and it would have even more trouble attracting foreign capital.

“Risk appetite will obviously collapse and gradually the currency crisis is likely to take the shape of a balance of payments crisis,” Nitsure said.

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“Suddenly everything seems to be coming to a head in India,” UBS wrote. “Growth is disappearing, the rupee is in disarray, and inflation is stuck at near-record levels. Investor sentiment has gone from cautious to outright scared.”

The Wall Street Journal wrote last week:

The venerable folks at FICCI [the Federation of Indian Chambers of Commerce and Industry] today held a press conference to try to galvanize the body politic – indeed, the nation – into ameliorating what they already termed an economic “crisis” for India.

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R.V. Kanoria, president of the Federation of Indian Chambers of Commerce and Industry, had the following bullet points:

–In 2007-2008, government revenue from tax and elsewhere totaled 5.4 trillion rupees while total expenses were 7.1 trillion rupees, a shortfall of 1.7 trillion rupees. That was covered by 1.3 trillion rupees in government borrowings and other receipts. So the government overspent its income by one third and financed about one fifth of its expenditure through borrowing.

–Fast forward to 2011-2012. Revenue = 7.7. trillion. Expenses = 13.2 trillion. Shortfall = 5.2 trillion. The gap was funded largely by 4.4 trillion in borrowing. So the government borrows almost two thirds of what it earns and one third of what it spends. The fiscal deficit now amounts to about 68% of revenue.

–Today, a large piece of government spending is committed to fixed items such as interest payments (2.8 trillion rupees), defense spending (1.8 trillion), and subsidies (2.2 trillion.) So, Mr. Kanoria said, “there is very little room for the government to channelize spending to investment,” which is what is really needed to reverse the economic slump. That will be even tougher if the government proceeds with a food security bill this year (+1.5 trillion rupees in spending.)

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What’ s the difference between 9% Gross Domestic Product growth and below-6% where we are now? About 30 million jobs that won’t be created, FICCI officials said. In a country that has 13 million young people come of working age annually, that shortfall matters. Goodbye demographic dividend, hello demographic disaster.

Business Insider has 8 charts here (and a new one here) to give a visual overview of India’s economic problems.

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