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Indian Fiscal Budget 1997-98: Analysis
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If anything, this year's Budget Speech was designed to earn kudos from the domestic large corporate sector and international financial markets. It was clearly the urge to please an elite which is already extremely pampered, which prompted Shri Chidambaram's many concessions to large industry, financial investment and the middle classes, even at the cost of ignoring or downplaying the material interests of the vast majority of the population. Some of the more blatant and partisan of the many pro-rich measures in the budget include the removal of taxation on dividend income, the reduction of corporation tax rates and the dilution of the Minimum Alternative Tax on companies which was introduced the previous year. Together, these amount to massive handouts from the public exchequer to this particular segment of the economy.
The fiscal irresponsibility and adverse distributional implications of these tax measures are so obvious that the Finance Minister himself must have noticed them. Going ahead with them nonetheless was a statement of choice and of establishing very clearly which group's interests are closest to his heart. Thus it is apparent that the perceptions and intentions of financial markets and large corporate entities have become most significant in terms of dictating economic policy. As a result, Shri Chidambaram's first priority, evidently, was to revive and boost a sagging stock market, followed closely by the need to placate and become more attractive to Foreign Institutional Investors. And these goals were considered so significant that crucial developmental matters which affect the well-being and living conditions of workers, and even basic rules of fiscal prudence, have been sacrificed to appease the uncertain gods of financial markets.
Yet these markets are fickle friends, as the Finance Minister is now discovering to his cost. The immediate response to the Budget was unqualified praise for it from Chambers of Commerce, representatives of foreign institutional investors and stockmarket dealers. The bullish sentiments were then expressed on the first day of trading after the presentation of the Budget, by heady euphoria in the exchanges, with soaring values of the Sensex and other stock market indices. In fact, so great was the general jubilation in capital markets that we were treated to the spectacle of the reappearance of the "Big Bull" made infamous in 1992, Harshad Mehta, who once again became the symbol of financial greed as he urged small investors across urban India to invest quickly now that the stock market was on the threshold of another major boom.
But within two days, downward tendencies in share markets began to manifest themselves. Since then the stock market has plummeted, with the Sensex showing a fall of 220 points (around 5.5 per cent) in just seven days. Coming so soon after the loud expressions of post-Budget enthusiasm voiced in financial circles, this must have been a source of much embarrassment to the government. But worse was to come, when Moody's international credit rating agency announced that it was putting India on "credit watch" because of a negative assessment for the future.
Some background on this may be necessary. Credit ratings are "expert" opinions of the likelihood that a debt issue will pay principal and interest over time. Rating agencies are independent companies which provide expert financial analysis and opinion to the financial markets, which in turn determine the access to and terms of debt contracts, securitisation, structured financing and the like. In developing country "emerging markets", ratings are typically given not just to particular corporate borrowers but to the market (country) as a whole. Thus, a low rating for a country will affect access to the international credit market and terms for new borrowing not only for the government but also for individual corporate borrowers, and such a rating will certainly also affect investment in securities in that country.
The two largest and best-known credit rating agencies are Standard and Poor's Corporation and Moody's Investor Services, both based in New York. Their ratings use a descending scale, and are typically divided into two major categories : investment grade (considered to be reliable investments for fiduciaries inter alia) and speculative or "junk" grade. Standard and Poor had already placed India within the speculative grade last year, suggesting that loans and investments in the Indian market are relatively high risk for the international investor. Moody's had maintained India in the lowest of its investment grades (Baa3) but it has now announced that it has put India on "credit watch", indicating a negative outlook and suggesting the imminent possibility of downgraded rating to speculative grade.
This suggests that, notwithstanding the government's attempts to woo foreign investors in particular, the credit rating agencies at least are not convinced of the viability of the government's economic strategy. This is hardly surprising, since it is clear to most independent observers that the economy is far from healthy at the moment, and that a high-risk budgetary strategy which assumes very high buoyancy of tax revenues with falling tax rates and puts its entire reliance on private investment while reducing public capital investment and expenditure in important social sectors, is entirely misplaced in the present context. Standard and Poor's had already made it clear that any future upgrading of India to investment grade would depend critically on how the government manages its finances. Moody's, in a similar vein, have now indirectly expressed scepticism about the revenue figures presented in the Budget, and pointed to possible future difficulties in servicing sovereign debt obligations.
This assessment is very bad news for Indian companies (including public sector companies) which have been forced by government policy, to seek more and more of their funds from commercial borrowings (including external loans) and external capital issues in the form of Global Depository Receipts. There is likely to be a reduction in external debt flows, and Indian companies will have to pay more for their external commercial borrowing. Since loans of several large public sector companies like ONGC and Oil India Corporation come up for renewal in the very near future, this will definitely affect adversely the terms on which such renewals are contracted, and may even make access to credit less secure. And Foreign Institutional Investment in the Indian stock market is also likely to be affected, despite disclaimers to the contrary. It the downward trend in the stock market continues, it is also bad news for the government which hopes to generate substantial revenues in the coming financial year from disinvesting shares in the more profitable PSUs.
While this is clearly of immediate relevance given the fact that so many major companies are now dependent on such financing for their future investment plans, there is a deeper question in all this. It is true that the Finance Ministry - and the government generally - may find this downgrading to be a source of major concern, since they are like the previous government in being obsessed with attracting foreign capital at any cost. But why does this matter so very much to the rest of the people in the country ? The key questions are whether we be concerned at all about what foreign credit rating agencies think of us, and to what extent should we direct our energies to pleasing them, rather than focusing on our own requirements for equitable development.
The answers depend crucially on the broader choice of economic strategy that is made. It is true that, given the extent of international financial integration that has already occurred, no government can afford to ignore completely the movements in financial markets. But it is even more true that a sustainable domestic growth pattern, based on domestic economic priorities of improving the living standards of the bulk of the population, is far more likely to attract long-term productive investment into the country, and far less likely to give rise to short-term speculative capital movements which can only destabilize domestic processes. Thus the successful fast-growing Asian economies which have also made use of foreign capital inflows, have done so largely on their own terms in and in explicit accordance with their own development priorities. In fact, it has typically been the case the foreign capital inflow into these countries has followed economic growth, rather than created it. It is also true that in general these successful Asian countries have not exposed themselves to the whims of speculative capital as much as India already has, since foreign investment in their nascent stockmarkets is far more controlled than in the case of India.
The obvious implication is that it is important first of all to set the domestic economy in order, and assume that foreign capital (or indeed, mobile capital of resident Indians) will follow, rather than to rely upon external capital flows to provide the panacea for domestic economic ills. The preferences of domestic investors must be subservient to the economic needs of most of the country's citizens. So economic policy has to be directed at domestic economic needs; it cannot be focused on pleasing Moody's et al to the detriment of the material progress of most of our residents.
But the latter course is precisely the one being taken by the present government. This is really a continuation and extension of the track laid down by the previous regime. It had already become evident that this is a highly problematic, risky and inequalising trajectory. Both the the previous government and this one have placed all their hopes on private capital, both domestic and foreign, and expected that more concessions to them would lead to substantial increases in productive investment. Since 1992 and to date, the Finance Ministry has attempted to woo foreign investors in both the Indian stock market and in FDIs, and allowed domestic companies greater access to external commercial borrowing, in the hope that this will unleash animal spirits in the economy and create a stock market boom which will allow companies to access capital more cheaply. This is why every minor fluctuation in foreigners' assessment of risks in the Indian market has been either a matter of complacent self-congratulation or of nervous apprehension, depending upon the nature of the movement.
This strategy is problematic because it is now clear that sustainable increases in the domestic investment rate have to be generated primarily out of increased domestic savings and that systematic public investment for filling infrastructure gaps cannot be easily replaced by private enterprise. It is risky because it exposes the Indian economy to the whims of financial speculators, both domestic and foreign, and creates potentially highly destabilizing tendencies. And it is deeply inequalising, because the benefits of the strategy can accrue only to the small elite, but the costs if it fails will once again be borne by the mass of people who have been excluded from the gains. This is a very fundamental criticism of a government which came into power with the explicit mandate of reversing the anti-people economic policies of the previous regime, and whose Prime Minister claims to working for "the poorest of the poor".
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Jayati Ghosh Associate Professor Center Economic Studies
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