India Intelligence Report

   Sustaining Economic Growth


The Asian Development Bank (ADB) Board meeting at Hyderabad provided a unique opportunity for India to listen and share ideas with Asian peers on global fiscal, foreign exchange, trade, and financial issues. While Standards & Poor (S&P) and Moody’s ratings dominated the fiscal debate, the ADB meeting cornered foreign exchange and trade management issues.

S&P, Moody’s Ups India Rating

S&P and Moody’s have both improved India’s rating and have counseled sustained reform, especially to improve its debt levels and decrease deficit levels coupled with policies that will facilitate growth to increase the rating further. S&P International Public Finance & Financial Services Rating (Asia) Director (Sovereign) Ping Chew projected a strong Gross Domestic Product (GDP) growth and fiscal improvement to change its rating from “stable” to “positive.” Moody’s changed the rating from “negative” to “stable” citing improvements in the country’s debt scenario arising from cost savings from lower interest rates.

Need to Watch Fiscal Risk

Chew cautioned “this effort of fiscal consolidation should start to address the principal credit risks on India, which are generate by a weak fiscal profile especially its ‘high deficit and serious fiscal inflexibility’.” He highlighted the risk that India’s fiscal weakness is one of the worst in the rated peer-group sovereigns and said that this would make it vulnerable to any ‘secular’ decline in growth rates and make it more susceptible to interest rate fluctuations. Moody’s also warned India of fiscal situation being at very high levels when compared to its peers. 

He complimented India on “some” success in its efforts to reform its Government-owned economy, inability to sell state-owned enterprises, and constraining reform labor laws but called for more forward-looking action. He cited the recent State Bank of India (SBI) strike as examples of how communist-philosophy based action can create chaos in the banking industry. The unreliability of power supply alone illustrates the challenges that India has to address to create an “effective administration.”

Moody’s complimented India on recent policy changes such as widening tax base accomplished by sustained reform of a decade and near total implementation of the Value Added Tax (VAT) in all the States. However, Moody’s cautioned the risk of economic implosion due to coalition politics that may cap fiscal consolidation as well as deeper structural economic reforms. It expressed confidence in the nation’s leaders’ learning on the importance of reduced debt and favorable private investment policies.

FDI Policy is Evolving

Acknowledging the limitations of structural reforms in place so far, Finance Minister P. Chidambaram told the delegates of the ADB that Indian Foreign Direct Investment policy is “evolving.” He cited several success stories of companies operating in India but acknowledged the “concerns” about India’s FDI policy. He said that the Government was working to correct these limitations that would bring in a fair share of the second wave of manufacturing outsourcing valued at USD 1.6 trillion. Referring to the impact of interest on India’s fiscal policy, he conceded that high oil prices and global imbalances on current account positions such as the USD 850 billion US budget deficits may have a “spill over effect” on domestic interest rates and foreign exchange management. However, he asserted that since India’s growth depends more on internal consumption and not export driven, global challenges will not have the same negative impact on India as it would on Far East Asian countries. He said that the Reserve Bank of India (RBI) while moderating the credit flow to real estate, capital, retail, and housing markets has ensured that economically critical sectors are not affected by the interest rate adjustment.

He called on the ADB to change its policies from public project funding to finance private sector companies in member countries that work on public projects. However, he criticized the ADB for supporting policies or initiatives that divide the Asian community such as the “Asian Currency Unit” (ACU). The ASEAN + 3 countries (ASEAN, China, Japan, and South Korea) are talking about creating a Euro sort of currency for Asia but leaving out India, Australia, New Zealand, and other countries who could participate in this exercise. While these countries are talking about an ACU, experts say that such a plan will not see any fruition in the near future because of cultural, economic, social, and regional complexities.

Pan Asia Free Trade Agreement

Prime Minister Manmohan Singh called for a “Pan Asia Free Trade Agreement (FTA)” to open new growth economies and create avenues for investment of savings and surpluses generated in the region. He also said that it would help establish standardize exchange rate management, monitor and manage corporate debt, and enable the countries and international agencies to respond quickly to a crisis. ADB President Haruhiko Kuroda agreed with Singh saying that an Asia-wide economic community will “benefit all its members as well as the rest of the world.”
India has already established a FTA within the South Asian Association for Regional Cooperation (SAARC) countries, Singapore, and Thailand and is working on similar agreements with Association of South East Asian Nations (ASEAN), Japan, China, and Korea. These FTA and booming trade has propelled India to become the world’s 17th largest importer and 29th largest exporter. It is also the world’s 10th largest exporter and importer of commercial services compared to 15th and 16th last year. Even though India exports jumped 19% to USD 89.8 billion this year, it is only .9% of the world’s export share. India imports USD 131.6 billion or 1.2% of the world’s total imports. Non-oil imports are valued at USD 86.6 billion giving the country a marginal surplus. India imports 73% of its crude oil and natural gas. Rising oil prices will only increase the budget deficit forcing India to look for alternate ways to bridge the gap.

Small Medium Enterprises Are Bullish

The UPS Asia Business Monitor survey says that 77% of Indian Small & Medium Enterprises (SME) said that business prospects are “better,” 71% look to hire talent, and 43% thought India will outpace China. While leading Asia in growth at 9%, Indian SMEs suffer from major challenges to sustain its growth.

They say that Government policies and regulations, access to cash flow and funding, shortage of qualified and employable labor, and innovation are major issues that they have to address to ensure long-term sustained growth. They also point out that the “supply chain efficiency and transport infrastructure” greatly affect their competitiveness.

Risks in the Horizon

An International Monetary Fund (IMF) report said that rising interest rates and changes in cycle of credit, non-performing loan assets with Chinese banks, poor quality and non-transparent business loans in China and India, and surge in mortgages and complex financial products in ASEAN are significant threats that are appearing the horizon. While emphasizing that the world’s economy is well rooted, the IMF insisted that these threats have a propensity to spin out of control if they are not managed well. Several IMF board members warned about looming risks arising from global imbalances such as household debt charges and under valuation of underlying risks to some types of investments. Several Central Banks have initiated measures such as increased obligatory cash reserves and tightening lending rules but has seen only moderate success.

Other serious threats that could arise would be the explosion of bird-flu cases, war in Iran other parts of the world, terrorist attacks, sharp drop in oil supply, and protectionist policies. These risks cannot be quantified but countries need to develop retaliatory and proactive plans for each of these scenarios.

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