Can We Stall Disinvestment Further?

The rating on India’s long-term debt has been cut to BB-plus from BBB-minus. Ratings agency Standard & Poor has, on the 19th of September, lowered India’s local currency denominated debt rating to ‘junk’, based on the poor level of public sector finances, and the recent failure in pushing privatization measures. This, the agency has said, surely lowers investor confidence and forces the government to borrow more. The slow pace of economic reform, and a growing sense of gloom, weakens India’s position and further weakens its potential.

This year has not been very heartening for the Indian economy. The recession worldwide recession and terrorist acts in the capital started a year of gloom. The much-heralded budget that came next failed to take off. The share market has collapsed yet again. Investigations into irregularities in the government backed mutual fund manager, Unit Trust of India (UTI) created enough doubts to send tremors in nearly all sectors of the economy. The rain gods too delayed their decision, and by the time they smiled, it was indeed too late. On top of all this comes the infighting among the NDA partners, pulling in opposite directions over the issue of disinvestments.

The external verdict had come earlier too and predicted bad times for the Indian economy. Standard and Poor downgraded India’s credit rating last August and Moody’s followed suit. These credit rating institutions are independent bodies that monitor performances of all economies. Based on a number of political and economic factors, they pronounce judgments on the stability of domestic markets. Countries are thus rated and foreign investors are warned against investing in unstable economies. Foreign investment coming in to any country depends to a large extent on these ratings, and a downgrade almost always ensures a drop in foreign investment. UNCTAD’s World Investment report 2002 in its FDI performance Index has ranked India at a lowly 119th position, behind China, Sri Lanka and even Pakistan.

The writing has been on the wall – it is only that now the signals come from foreign agencies too. The Reserve bank had already raised objections to expenditure in various states going over budget. The Economic Survey, the Government’s own statement on the economy’s performance had sent early warning signals and warned of the perils of excess spending. The market sent its own message by allowing most share prices to collapse. The industry all but announced its doubts on the government’s ability to control budgetary deficits and stimulate growth and cut wasteful expenditure.

These last few days are clearly reminiscent of the Indian economy ten years ago. The August 2001 ratings downgrade recreated the events of August 1990. Moody’s had on 1st August 1990, placed India on credit watch for a possible downgrade. Six weeks later Standard & Poor downgraded India below the Moody’s rating. The Japanese Bond Research Institute downgraded India further. Then it was “political risk” that caused the panic. The cause now is a combination of a fractured coalition in power, failure to privatise the public sector, mounting internal debt, and growing deficits.

In 1990-91, the fiscal deficit as a ratio of GDP was 7 percent. Estimates are that the year-end figure would again be near 7 percent. Fiscal deficits are dangerous as they either cause inflation, or push interest rates up because of government borrowing. This results in a shortfall of private sector investments and therefore fewer jobs. The immediate answer lies in curtailing government expenditure. This alone would bring domestic borrowings down and check against budget deficits. However this is easier said than done. In India’s case, government expenditure consists of four major components – subsidies, wages, defense expenditure and interest payments. On subsidies, there are some steps in the right direction. Sugar has been denied to income tax assesses and other issue prices have been hiked for those above the poverty line. Urea prices have been hiked too. However, the salary bill for government employees that includes pensions continues to be high and worrisome.

Defense expenditure has gone up as was expected. And it is ironical that nearly 80 percent of defense expenditure goes to pay salaries and wages, while the argument that sustains a high expenditure on defense is that of national security. Interest payments therefore were the only area where much could have been done. But here the public sector that eats up much of public debt needs to be privatized. But this is clearly not happening in a hurry. Caught in internecine wrangles over the merits and demerits of selling its wares, the government is unable to move forward. Not even when faced with the prospect of slower economic growth, a bad recession in industry and no signs of a quick recovery in international markets. This downgrade could not have come at a more inopportune time. China has entered the World Trade Organisation(WTO) and is India’s biggest competitor for foreign funds. Facing this threat, the need of the hour is tighter and stringer fiscal management, and not profligacy leading to higher debt burden and poor forecasts.

In all this, a ray of hope emerges in the form of a rupee that is holding stable. Helped by a slowing down of imports and an inflow of equity in certain areas, the domestic currency hasn’t taken the free fall it was expected to. Some intervention by the Reserve Bank and other state owned banks has helped protect the rupee. Also foreign direct investment and equity investment have been robust, taking foreign currency reserves to record highs of over $58 billion. However fickle foreign institutional investments are, a strong reserve always helps. In this backdrop there is really no alternative to disinvestments of the public sector and the reining in of government spending. Else we shall have the credit rating agencies targeting India once again, very soon.