india economy strengths and challenges

Indian economy strengths and challenges

On June 23, 2011( DB RS) changed the trend on  Republic  of India long term foreign and local currency debt ratings to stable from negative to stable from negative. The reasons for change are progress in fiscal consolidation in the context of strengthening policy frame work, and return to pre crises growth. Combined these have continued the decline in India’s debt ratios. If these trends continue, the rating could come under up word pressure over coming year.

Evidence of stronger commitment to fiscal deficit reduction came with the 2011-2012, budget. Estimates indicates that general government deficit will decline from 8.3% G.D.P. in 2010-2011 ( 8.7 % of GDP  excluding privatization receipts) to 5.4% of GDP in 2014-2015. DB RS estimates that this effort , combined with reduction in subsidies, changes in tax code and privatization of state asserts will result in a further reduction of net general government debt from current level of approximately 65 % of GDP.

Several recent reform initiatives further support ratings. The government is addressing the country’s infrastructure deficit by spending US$ 514 billion or 90  %  of GDP, on infrastructure between 2007-2012 and  additional US$ 1 trillion from 2013-2017, approximately one half of which may come from the private sector and public private partnership. India has liberalized petrol prices and in corporate oil , food and fertilizer bonds on to the budget. A new direct tax code which could improve tax code which could improve tax efficiency may be enacted in April 2012. Once introduced, a national identification card may be in coming years increase labor market formality , gain tax complaisance, and steam line subsidies and social security expenditure.

A constitutional amendment was  submitted to parliament in March  2011 to introduce a national goods
And service tax which could reduce cascading taxes and improve tax collection. 

Strengths of Indian economy
1.strong economic growth and very high saving.
2. Favorable composition, maturity of public debt.
3. Record of gradual economic reforms
4. Well established democracy and legal system

Challenges
1. High government debt and fiscal deficits.
2. Persistent high inflation
3.under developed financial inter mediation
4. Large development and infrastructure needs.

Rating up date

India’s  fiscal monetary policy response to the global credit crisis helped restore economy to a path of higher growth.
The economy has weathered  the global credit crisis relatively well, and strong private sector - led recovery has returned India growth rate to pre -crisis levels. The government estimates that growth over the next five years will average 9%  ( plus or minus 0.25%.)

However , DB RS remains specifically concerned  about two issues. First India debt ratios  are among the highest  among developing economies.  The government has made progress in rapidly reducing net  general government debt from 81.9 % of GDP in  2005-6 to 66.6 of GDP in 2010-11 ( DB RS  definition which includes transfers and subsidies. However  like many low to middle income countries with relatively low tax in takes, India’s debt burden remains high and further progress the lowering debt ratios would strengthen credit quality. Further more the general government deficit was relatively high 8.3% GDP in 2010-11, food and fertilizer price subsidies are costly and estimated 53.9 % of revenue will go  paying interest on debt in 2011-2012.
Second India suffers from high inflation inertia and poorly  anchored inflation expectations. Causes of Indian inflation appear to include high international food, energy  and commodity prices, combined with domestic pressures including little economic slack , high money supply growth inefficiencies  in agriculture and other domestic factors which contribute to food price inflation. Tighter fiscal and monetary policies and over time better infrastructure and structural reforms should help to anchor inflation expectations.

Up word pressure on ratings depend on adherence to fiscal targets and progress on structural reforms. If deficit reduction stalls, DB RS is likely to mention a stable trend. Overall , India has adopted a more responsible medium term fiscal policy and commitment to debt reduction and this bodes well for ratings.

Foreign vs. local currency ratings
DB RS rates India’s  foreign and local currency ratings at same levels, because DB RS  considers the central government capacity and incentive to service its foreign currency securities to be at same level as its local currency securities . Numerically , external refinancing risk is far lower than domestic risk, with external general government debt at only 4.3% of GDP and domestic debt at 70.7%  of GDP. India is also a net external creditor and, by policy the government long term external borrowing is restricted to  multilateral institutions and bilateral government sources, which provide long maturity loans at below market interest rates. However the domestic public debt burden is for higher than that of external public debt, and therefore carries more rollover  risk.