India still needs careful policy management
High-frequency data suggest that the Indian economy continues to recover from the pandemic-induced disruption. Encouraged by the ongoing economic recovery, Moody’s Investors Service changed its outlook on India’s sovereign ratings from negative to stable on Tuesday. It has revised its growth forecast to 9.3 per cent for the current fiscal year and 7.9 per cent for the next year. In Moody’s opinion, the recovery is getting entrenched, and the risks emanating from banks and non-bank financial institutions are far lower than what the agency had anticipated. Besides, India’s external position is fairly strong with a record accumulation of foreign exchange reserves. However, Moody’s retained its ratings at the lowest investment grade.
The upgrade in outlook is definitely a relief for India because a downgrade below investment grade, which was a risk, would have increased policy complications. Most global money managers are mandated to invest only in countries above a certain ratings threshold. As things stand today, Moody’s and Standard & Poor’s have a stable outlook on India. Fitch continues to maintain a negative outlook. An upgrade in ratings outlook, however, should not lead to complacency in India’s policy establishment. Although the recovery from the second wave has been swift, India still has a long way to go, and the real output at the end of the current fiscal year is likely to be only marginally above the level attained in 2019-20. Recovering from a contraction, India will post a higher growth rate in the current year, and the momentum is likely to be carried forward into the first half of the next fiscal year. But economic growth in the medium term would depend on a variety of factors.
It is worth remembering in this context that the Indian economy was slowing even before the pandemic hit. One of the big constraints for growth in the coming years would be India’s fiscal position. India’s debt-to-gross domestic product (GDP) is estimated to have reached about 90 per cent. Although tax collection has improved significantly in the current year and will help contain the fiscal deficit, higher debt stock will remain a constraint on government spending in the medium term. Private consumption is also likely to remain weak. Growth in years preceding the pandemic was driven by private consumption, partly financed by debt, and higher government expenditure. Income for a large number of households has been hit because of the pandemic and they are likely to repair their balance sheets before increasing consumption. Private investment is also likely to remain tepid because of weak consumer demand and existing spare industrial capacity.
Sustaining higher growth, therefore, would require careful policy management. Exports, for instance, are doing well, and to maintain higher growth, India would need to review its trade policy. Higher tariffs and import restrictions are big roadblocks for exports. India has been negotiating trade deals with a number of countries for quite some time and should aim to conclude them soon. The government should also reconsider its decision regarding joining the Regional Comprehensive Economic Partnership. It would be difficult to maintain higher economic growth without higher exports. Further, India needs to address its low tax-to-GDP ratio. This would require changes in both direct and indirect tax systems. A higher and stable tax-to-GDP ratio will not only enable the government to spend more on capacity creation but also improve India’s fiscal profile. This would surely be ratings positive.