The initial reaction was one of shock and disbelief. Then, true to our national character, vehement denial. Here we are, Asia's biggest emerging market and infotech powerhouse, how can we be downgraded by a credit-rating agency like Standard and Poor's? Especially when Moody's has confirmed its positive outlook on India? Surely S&P's is over-reacting to a little fiscal slippage and industrial slowdown?
Is S&P's acting a little too propah by downgrading India's investment outlook from positive in March to stable now? Let's look at some general numbers. The April-June industrial growth rate has slipped to a pathetic 5.6 per cent compared to more than 10.5 per cent notched during October-March. Could that be seasonal? Perhaps not, since even in the first quarter of last fiscal, the Index of Industrial Production grew by 7 per cent. As for the little fiscal overkill, combined central and state fiscal deficit is again back at 10 per cent of the gdp. With $3 billion vanishing from forex reserves and external inflows slowing down, the current account deficit is expected to double to $8 billion this year. Add to it the rising inflation, feared to touch 8 per cent, and the 66 per cent rise in petrogoods prices in a single year, you could be staring at a potential harkback to the pre-reform era.
If S&P's rating surprised many in the government like RBI deputy governor Y.V. Reddy and finance minister Yashwant Sinha, it's just a matter of statistical quibbling. Sinha anyway called an industry bigwigs' meeting ahead of the release of the credit policy and summarily told them to prepare a blueprint for industrial revival in seven days. Reddy said: "I was surprised by the rating because the main point raised is the fiscal situation.... The first few months the fiscal situation has been encouraging and we have indicated that we'd prefer to consider a reduction in borrowing for the current year."
He, however, is only partially right. The April-August fiscal deficit was Rs 36,447 crore, down a quarter from the same period in fiscal 1999-2000. On the receipts side, however, the picture is opposite: against an expected disinvestment proceeds of Rs 10,000 crore, the past six months have seen only Rs 233 crore slipping in.
And it's unlikely that we'll make up to stick to our deficit targets. More and more economy-watchers are coming to the same conclusion and that also includes the RBI. In its mid-term review of the monetary and credit policy, the RBI has continued with its policy of "cautious optimism" - that's RBI-speak for 'all's not lost yet' - and qualified its tone by saying that the outlook would have been grimmer but for the taming of oil prices and the Millennium India Deposit Scheme turning the forex market sentiment for the better. However, it has toned down its growth forecasts down from 6.5-7 per cent in April to 6-6.5 per cent. It has also debunked the Centre's growth projection of 7 per cent as impossible until "real investment growth occurs along with technology improvements and efficiency gains".
If RBI was prompted in part by the release of cso growth estimates in the first quarter (Q1) - 5.8 per cent compared to almost 7 per cent in Q1 of 1999-2000 - it's not the only one. The cmie has scaled its growth forecast from 7 per cent in July to only 5.8 per cent. And ncaer, which stuck to its 7 per cent forecast as recently as in August despite worrying trends in industry and BoP situation, is now speaking of 6. 4 per cent.
Why did we have such a great fall? Most likely because we were sitting on the wall for far too long. It's just a set of old problems that are crying out for new and drastic solutions. The voice of the industry is clear in the CII president Arun Bharat Ram's note for the FM meeting which says: "The biggest problem is the state of manufacturing. Uneconomic cost of capital, high cost and low quality of power, lack of flexibility in use of labour, poor infrastructure facilities and large-scale dumping by China which will grow enormously in the near future." Or in K.. Memani, partner, consultancy major Ernst & Young, who avers: "Industry is sitting on a lot of capacity but with demand growth flat, rising costs and stagnant prices for products, there is not much it can do. This has led to a sudden slowdown. As for investment in infrastructure, it's a chicken-and-egg situation."
Memani is bang on target. How long can industry and economy go on without infrastructure development? Says Sanjiv Goenka, VP, CII: "Some 29 sectors have shown very high negative growth in the second half and most of these are infrastructure and infrastructure-related areas - power, capital goods, pharma, automobiles, telecom cables, etc." Here neither foreign nor domestic private investment is coming in. Because domestic industry is not competitive or credit-worthy enough to sink in huge funds and foreign investors are either getting discouraged by procedural bottlenecks or are preferring to wait and watch as states continue to practise populism.
S.P. Gupta, member, Planning Commission, put it succinctly: "There's a huge gap between reform and perform. We seem to be doing a lot of the former, but not following it up with action. Now even the services sector is slowing down because the class of people it had benefited has a high elasticity of demand for consumer goods and that's saturated." Let's look at ground realities:
- Power reforms started eight years ago but is still mostly on paper except for a couple of distribution companies in Orissa and a lot of heartache in Andhra and UP. But costs are going up, especially for industry as initial reforms have meant a steep hike in tariffs in states.
- Software exports alone cannot achieve dramatic growth rise until manufacturing growth picks up. That is, firms achieve economies of scale and become competitive. Which they can't do because India still is a high-cost economy.
- Some say if the old economy is dying, let it. But are enough new enterprises taking its place? No. Thanks to a rigid financial sector, populated by battle-scarred banks and inflexible interest rates, lack of policy to encourage small and medium enterprises, and a capital market that's naturally reluctant to rev up.
- No farm sector reforms yet. This year, the rain god has been a little unkind and we're back to 1.3 per cent growth forecast, compared to 4.2 per cent forecast earlier. With agricultural incomes still key to a rise in overall consumer demand, neglecting reforms in this sector is suicidal.
- The government continues to be slothful, huge and bureaucratic. No downsizing, no respect for cost-cutting, no agreement on big-ticket reforms like privatisation (soft-pedalling for a decade now), insurance, opening up of infrastructure sectors like water and housing to foreigners.
The government can do a lot, assuming it wants to. For instance, start privatisation and small-scale dereservation, clear a few big infrastructure projects and give fillip to construction, allow a few power producers in without curbs, raise farm power tariff, change labour laws and downsize. It, however, might end up doing little: a few concessions and make some imports tougher.
Says Bernard Pasquier, South Asia director of ifc, World Bank's private investment arm: "We don't think a little slowdown could affect our long-term outlook on India, which remains very bullish for the long run. But then, a crisis usually goads a government into doing a lot of unpalatable but desirable things." Agrees Rajiv Vij, Templeton India head: "Despite the feel-good factor disappearing, I don't think it changes the long-term potential of this country. I hope now the government becomes proactive on privatisation."
Can we end on a note of hope? Only if, as Vij says, this serves as "a wake-up call, to turn our potential into reality. I see the pessimism continuing till the government takes some big steps to unlock value." The structural limitations in the economy will not go away without a big shake-up. And if the government shies away from it, it will lose the one chance in a millennium to put India up there in the global ranking of nations.