India Encounters Bumps in the Economic Road
While good demographics are an important ingredient for strong economic growth, they are insufficient on their own for the long-term. Governments must pursue sound/stable policies and have fiscal discipline. While we are dubious about the accuracy of the credit rating agencies, this downgrade by S&P is an indication of trouble for India. It will take political will to address the fundamental issues (sound familiar?):
The clouds gathering over India’s economy darkened on Wednesday when Standard & Poor’s cut its outlook on India’s long-term debt to negative and warned of a possible credit downgrade, a surprise move that challenges the nation’s image as a surging economic force.
S&P highlighted what it said was political gridlock that will prevent the Congress party-led government of Prime Minister Manmohan Singh from carrying out reforms to rein in its fiscal deficit. The party, hobbled by scandals and infighting in its coalition, has been unable to push through changes that would attract fresh investment, increase productivity and curtail spending on welfare and subsidies.
The shift by S&P is a startling turnabout for a nation that until recently was a darling of foreign investors. As European governments struggled with ratings downgrades that drove up their borrowing costs, India, with its strong growth and young population, has been seen as an attractive destination for investors looking for better returns.
But India’s economic growth slowed to 6.9% in the year that ended March 31 after back-to-back years of 8.4% expansion. Last week, the central bank cut a benchmark interest rate for the first time in three years in a bid to stimulate business spending.
Commerce Secretary Rahul Khullar said in an interview on Wednesday that India faces a huge challenge securing the tens of billions of dollars in foreign capital it needs to finance its current-account gap. He said European banks that have traditionally financed Indian debt could cut back lending amid the Continent’s economic woes, raising pressure on India to attract other foreign capital. “That’s the real problem,” Mr. Khullar said. “Where is the capital going to come from?”
India has frightened foreign investors with tax proposals that would increase capital-gains liabilities for foreign companies — in some cases with retroactive effects potentially back to 1962.
Net foreign capital investment in India dropped to $387 million in March from $7.2 billion in February after the government unveiled the proposals. So far in April, there has been a net outflow of about $27 million.
India’s budget deficit, a concern noted by S&P, touched 5.9% of gross domestic product in the year that ended March 31, wider than the government’s 4.6% target. The government spends about $57 billion a year on major subsidies to ensure low prices of fuel, fertilizer and food-grains, an effort to insulate impoverished consumers from rising global commodity costs.