Bangkok--8 Mar--Moody's Investors
Moody's Investors Service says that India's wide and persistent fiscal deficits could eventually compromise the country's macro-economic profile and that while the annual budget statement can set fiscal reform in motion, lasting fiscal relief will take persistent policy efforts over several years.
According to a new Moody's report, India's Baa3 rating incorporates India's fiscal drawbacks, including the dominance in revenue by highly growth-elastic taxes and rigidities in expenditure that prevent significant cuts, leading to heightened fiscal fragility during a slowdown in growth. It also encompasses credit strengths, such as high GDP growth and savings rates, which allow the economy to absorb the government's large deficits.
Over time, however, a failure to narrow fiscal deficits could endanger these credit strengths. Loose fiscal policy nourishes inflation, and persistent inflation, in turn, erodes the value of accumulated savings, raises capital costs, and discourages investment.
The report notes that while the Indian economy has tripled in size overthe last decade, the government's budget deficit to GDP ratio hasremained close to levels of 10 years ago, and is far higher than that ofsimilarly rated countries. More specifically, the report looks at whygovernment finances have failed to improve despite high economic growth.
The report points to the government's narrow potential tax base, whichkeeps India's tax to GDP ratio lower than the median for its ratingpeers. It also notes that the composition of India's tax revenues hasdiversified substantially over the last decade, and this trend is likelyto continue over the next 10 years, benefiting government finances.
However, in the absence of initiatives to incorporate profitable economicactivity that is currently outside the tax framework, India's tax to GDPratio is unlikely to rise to the levels of its rating peers. Policyproposals to expand the service tax are an effort in this direction, butit will still take years, the report notes, before the service tax'scontribution to government revenues is equivalent to the contribution ofservices to overall GDP.
The composition of government expenditure has remained fairly rigid overthe last decade, with interest payments dominant, reflecting thegovernment's high debt burden. Moreover, there has been the addition oflong-term claims on the government's limited resources via policyinitiatives such as employment guarantees and the Food Security Act.Lastly, despite efforts to reduce fuel and fertilizer subsidies since2010, the government's subsidy bill has risen due to exchange ratedepreciation and global commodity price movements.
The report is entitled India's Fiscal Deficits: What past trends portendfor the future. It can be found at www.moodys.com.