The Hindu Business Line : Moody’s rating too conservative

Chennai, Aug. 7 Negative marks for a country which runs a deficit in its national accounts is almost an axiom with the rating agencies. The closest analogy to this in the world of macroeconomics is the circumspection with which a country’s trade deficit on the overall balance of payments is looked at. In both cases, it is possible to take a less pessimistic view if the composition of the deficit(s) is analysed more closely.

For instance, if a budget deficit is run only to finance investment over the business cycle (like how this has been institutionalised in the UK in the last 10 years), it may not necessarily leave overall public finances in a vulnerable state. Similarly, if a country’s trade deficit is more on account of imports of investment goods such as machinery, the deficit per se need not be a negative factor in the overall external finances.

Axiomatic decision

Moody’s retaining India’s local currency rating below investment grade would seem to be such an axiomatic ratings decision. While nobody can claim that India is in the category of the UK as regards the structural composition of the deficit, overall national finances and the underlying strength of the economy do not warrant a sub-investment grade rating either.

It can, with some justification, be stated that after the enactment of the Fiscal Responsibility Act , the quality of the overall budget deficit and the national debt is improving.

Large expenditures continue to be incurred and not all is in that category which creates physical capital assets. A long-term goal, for instance, is being pursued for improving the quality of human capital in the country. The National Rural Employment Guarantee Programme is a case in point. The national budget is also funding a broad project to renew and strengthen urban infrastructure across the country. The rating agency does not seem to have taken these qualitative factors underlying the deficit into account in formulating its ratings stance.

At a technical level also (as it relates to more immediate issues such as the cost of borrowings for the exchequer), the retention of the sub-investment grade rating may not have any adverse impact.

For one, the budget deficit is almost 100 per cent funded through the local markets — directly to a very major extent through the commercial banking system and indirectly through the administered savings schemes. As it is, there is negligible foreign exchange risk on the (market) debt portfolio of the government and it will continue to remain so given the incremental steps on permitting greater foreign investments in the local debt markets.

Over the long term, though, the scale of infrastructure spending planned in India — around $450 billion in the next 5 years — could exert upward pressure on the cost of borrowings. The policy challenge would be to devise such financing mechanisms as to put through that level of infrastructure spending without it “crowding out” other sectors of the economy.