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What is exposing the Indian economy to shocks?

India Infoline News Service | Mumbai |

Moody's Investors Service says that India's government budget deficits.

Moody's report titled, "Frequently Asked Questions on India's Fiscal Position and the Forthcoming Budget" outlines the reasons behind India's high fiscal deficits, provides a comparison between recent fiscal developments in India and in other similarly rated countries, explains how fiscal policy has affected growth, balance of payments and exchange rate trends and addresses the possible credit implications of the newly elected government's forthcoming budget.

Moody's Investors Service says that India's government budget deficits, which are higher than those in most similarly rated countries, increase macro-economic imbalances and thus expose the economy to shocks.

India's high budget deficits are partly due to a large population and low per capita income levels. Low income levels limit the government's tax revenue base and at the same time drive socio-political pressure to increase government spending on subsidies and economic development. However, Moody's notes that other countries with low per capita incomes have avoided deficits as large as India's. This suggests that fiscal discipline can improve budget outcomes despite structural challenges.

The report notes that wide budget deficits have kept India's inflation high and contributed to a widening current account deficit between 2011 and 2013 which heightened exchange rate volatility and resulted in higher domestic interest rates. These trends have exacerbated the slowdown in GDP growth since 2011.

However, the sovereign credit impact of high fiscal deficits was mitigated by the government's favorable debt structure. Indian government debt is owed mostly in domestic currency, at relatively low fixed real rates, and at long tenors, which shields government debt service costs to some extent from currency and interest rate volatility. These debt characteristics underpin the stable outlook on India's Baa3 sovereign rating.

Nonetheless, large fiscal deficits raise the portion of domestic savings the government absorbs in order to maintain its favorable debt structure. This hurts growth by limiting the private sector's access to those savings for investment.

In Moody's view, absent measures to reduce the fiscal deficit, the future high growth rates many forecast for India may not be realized. The July budget could indicate whether fiscal constraints on India's sovereign credit profile will ease over the coming years.

The agency adds that whether the new government's FY 2015 deficit estimate is above or below the previous government's estimate of 4.1% of GDP is not the key determinant of India's credit outlook. According to Moody's, more relevant to the sovereign credit outlook will be whether the budget includes measures that address the government's low revenue base, high current expenditures, and exposure to commodity prices

 

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