Why are rating agencies sceptical about the Union Budget?

That is a question that is on the top of everyone’s mind. How will the rating agencies react to the Union Budget? Will they consider a favourable rating upgrade post the budget? These may be early days but the initial response to the Union Budget was that the rating agencies were disappointed. Most rating agencies would have required clarity on 3 fronts viz. Growth & infrastructure, fiscal responsibility and global vulnerability. One can argue that at 7.5%, India is the fastest growing large economy. In fact, by 2016 India’s growth rate will surpass China also. But, there other statistics that are revealing! In terms of GDP per capita, India ranks below nations like Bolivia, Bhutan, Georgia, Swaziland, Angola and Paraguay. If you look at literacy within BRICS, India is still at 74%, while other BRICS nations are above 95%. That is a long way to go…

Growth and Infrastructure:

The Union budget has projected growth of 8.1% for 2016 and double digit growth in the next couple of years. This is, however, contingent on a turnaround in the capital investment cycle, low oil prices and low inflation. None of these parameters can really be taken for granted. Higher growth will also depend substantially on quality infrastructure, which requires over $1 trillion of investment to bring it to Asian levels. How the money will be raised, how private participation will be encouraged and how they will be implemented has hardly been laid out. Growth also becomes critical to sustain the higher than promised fiscal deficit that the Budget has spoken about.

Now for the fiscal deficit piece:

The Union Budget has made a conscious effort to pump prime the economy by compromising on fiscal deficit targets. For example, the target for 2016 has been raised from a projected 3.6% to 3.8% and the 2% fiscal deficit target has been postponed from 2018 to 2019. That is something most ratings agencies have not been comfortable with, considering the high debt levels and primary deficit that India runs. It becomes all the more imperative that this higher fiscal deficit gets translated into higher spending on infrastructure and in reviving the capital cycle.

How vulnerable are we:

This is a key question the rating agencies will be asking. Vulnerability to oil risk, currency risk and capital flow risk are still fairly large. Our ability to control inflation is contingent on low prices of oil and other commodities. The forex reserve situation will be comfortable as long as FPI inflows continue and gold imports do not shoot through the roof. And the Indian rupee will still depend on the magnitude and colour of portfolio flows.

The moral of the story is that there is unlikely to be an upgrade immediately. The principal rating agencies like Moody’s, S&P and Fitch have already reiterated that view. The ball is in the court of the current government. The quicker it delivers on its promise, the faster will there be a rethink.

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