Another warning

Structural changes needed in every aspect of the economy

Moody’s decision to change India’s credit ratings outlook to negative from stable is another reminder of the deteriorating economic situation. Most economists believe that economic growth in the July-September quarter is likely to have slipped below the six-year low of 5 per cent recorded in the April-June quarter. Growth in the second half of the fiscal year is expected to improve, but largely because of the base effect. Although the change in the ratings outlook is unlikely to have a significant impact, it will dampen sentiment further, as was evident in the stock market on Friday. Rating agencies generally tend to be behind the curve, but Moody’s rationale for the change in its view should not be ignored. It reflects an increasing risk that growth would remain significantly low compared to the past because of inadequate reforms to resolve long-standing economic weaknesses. This could lead to a gradual rise in India’s debt burden. Further, in its view, the possibilities of reforms that would support growth and significantly broaden the tax base have diminished. These are sharp observations and would not help India in attracting investment.

 
Although the government has taken steps in recent months to revive growth, they are unlikely to address India’s structural weaknesses. In this context, the government has sharply reduced the rate of corporation tax, but it will not be sufficient to revive investment in the short to medium term. India needs more flexible land and labour markets. For instance, India decided not to be part of the Regional Comprehensive Economic Partnership, at least for now, because of the fear of higher imports. The fact that India could not see this as an opportunity to integrate with the global value chain and become an integral part of the fastest-growing region in the world shows that it has not done enough, over the years, to overcome structural weaknesses and improve competitiveness. This is also reflected in India’s exports, which are virtually stagnant for years. It is hard to attain higher sustainable growth without higher exports. However, what is worrying is that there is practically no policy road map that will help India become more competitive.

 
India needs to address multiple issues. For instance, one of the biggest reasons for the sharp economic slowdown is the stress in the financial sector. While the government and Reserve Bank of India have taken several steps, which would relieve some pressure in the short run, the financial system will continue to be dominated by public sector banks, which are prone to misallocating credit and would remain a drag on the exchequer. Government finance itself is under stress and revenue collection is likely to fall short by a significant margin. Part of the problem is again fundamental. Even after over two years of implementation, the government has not been able to fix the gaps in the goods and services tax. This is affecting its ability to spend in productive areas, which would have helped push growth. Essentially, India needs structural changes in practically every aspect of the economy. For example, its record in contract enforcement is among the poorest in the world. While policymakers may choose to ignore Moody’s warning, the world will not.