Public Finances - Rating & Realities    

28 Sept, 2002

It is said that "in the land of the blind, the one-eyed is the King! Or atleast a pretender to the throne"; if one were to paraphrase a bit. The axiom has equal relevance in the world of financial analysis and interpretation. There are laymen who are honest to themselves and others and pretend not to know much about the world of finance. Therefore, they do not pass judgement at the drop of the hat! There are others that rush in with a comment when asked, based on what they think is the problem and the solution. These include many learned professionals and scholars, some of whom may well have experience elsewhere, say in accounting or auditing but who nevertheless, have an opinion on everything under the sun; on the strength of their limited familiarity with finances per se.

S&P RATINGS & INDIA : A recent case in point is the reaction to the announcement by the global rating agency, S&P, of a downward revision to India's local currency ratings to below investment grade. Effectively, this categorises India's local currency-denominated securities and repaying capabilities to 'junk bond' status. This rating 'action' produced an equal and opposite reaction; with some aggrieved individuals taking this personally and viewing it as an affront to national honour.

There was much hue and cry in some quarters saying how India is achieving 6% p.a. GDP growth rate; when most global economies are struggling with 1% or 2%, if not negative growth rates. The other observation made was that India has about US$ 60 billion in foreign exchange reserves and that to date, it has unblemished debt services credentials.

Attention was also drawn to the fact that India is one of the largest economies in the world, if measured on the Purchasing Power Parity (PPP) basis and that it is too large an economy to be categorised with the banana republics, be it in Latin America or elsewhere.

All these are true but miss the point. They are tinged with misguided patriotism, misplaced concern and are a misinterpretation of the real message from S&P. Screaming newspaper headlines that "S&P junks India" are also highly misleading and sensational. What is needed is a dispassionate review and a considered response to serious issues such as ratings revision.

S&P concluded after much deliberation and deep analysis that the domestic financial status of the sovereign has deteriorated. S&P was highly concerned, as it and indeed the public authorities in India should be, about the state of public finances at the central and provincial level; perilous and parlous! Quite a few states are teetering on the verge of bankruptcy running huge fiscal deficits. Some have come to a stage where they are not able to pay monthly salaries to their bureaucrats on time. Almost their entire budgets, in some states, are spent on non-developmental current expenditure and on overheads. Furthermore, some continue to create sinecure positions and parasites (not jobs as there is little or no work) in the state administration.

At the central level, the situation is only a little better. But even so, the overall fiscal deficit is alarming enough; if one were to aggregate that of the states. A few years back, it was bloated further when the authorities spurned the opportunity to implement the Fifth Pay Commission report in toto i.e. cut government jobs and accompanied by a pay rise. Instead the Government of the day chose to increase the salary bill while making only token cuts in staff numbers. This is a real problem where ministries and government functionaries are becoming behemoths and eating up a major portion of the income generated from taxes. Defence forces have also grown substantially in terms of both staff numbers and expenditure on equipment. Cutting even a small portion will amount to committing political hara-kiri; for any politician ministers.

Ultimately, the management of public finances requires both gumption and skills to make sensible but tough decisions. That blend seems to be incompatible with the democratic system, as it is practised in India and in many other developing worlds. Democracy was meant to be a 'means to an end' i.e. welfare, progress and growth for the citizens of a country.
Instead, it has in some instances, degenerated into a self-perpetuating week-kneed system of vested and conflict of interests. It is arguable whether in the manner in which it is practised, it is the most effective way of managing economies. This issue may rightfully belong to a wider debate on the merits of separating the economy from the political system and allowing professionals to manage the finances in a manner similar to what obtains in the corporate world i.e. the management is professional, recruited on merits but accountable to boards of elected directors and to the shareholders. Such a management is then liable to be changed, if its performance does not measure upto the expectations. The shareholders or the Boards themselves do not interfere in the day to day management. A similar system needs to be evolved for public finances. Too many politicians in the emerging markets, have snatched away the executive authority from the line managers of the economy; in the guise of their being the elected-representatives of the people. This should not necessarily vest in them the right to make day to day decisions on all and sundry matters. This is the nub of the problem. S&P has drawn the attention to the fact that even if India's servicing of external debts is fully within its capabilities, and its US$ 60 billion fx reserve, its domestic public finances are in a bad shape and is in need of urgent remedies.

FISCAL RESPONSIBILITY BILL : It is in this context, that the fiscal responsibility bill before the Indian Parliament, envisaging a method of attaining balanced budgets within a short time frame is commendable. Specific targets and time lines in reducing budget deficits, are pre-requisites in every province in India. This is also required in other large countries such as Brazil, Indonesia, Nigeria and Egypt. It is only when the public finance responsibilities are drilled down to unit level; and accompanied by accountability for balanced budgets, can this problem be fully and finally resolved.

Pendulum swings in public finances are of course not unique to India but are a global issue, be it in the U.S., where a few years back, under President Clinton, there was a surplus budget at last. Thanks to the new administration and its tax cuts, we could witness a deficit developing and spinning out of control in a few years. The situation is no better in Europe, although the "convergence criteria" of the European Union (EU) has helped; as it has imposed a discipline that the politicians in France, Spain etc. had little choice but to implement the criteria and could not resist if they wished to stay in the EU.

All these require stupendous political will. With elections around the corner every other year, the so called-political representatives have neither the time nor the focus on finding realistic and lasting solutions. All enduring remedies tend to be longer-term in nature and are slow and often painful in curative terms. It is therefore important to draw the right conclusions when even S&P or other rating agencies send a strong signal of impending but intractable illnesses. Otherwise, we could all end up arguing about whether the message itself was correct rather than acknowledging the severity and the gravity of the situation that is crying for a solution.

In the ultimate analysis, the deterioration in public finances in India is not a crisis but a chronic malady. What is needed therefore, is not a band aid to be applied on the haemorrhage but surgery for the deep wounds. A true test of statesmanship (as opposed to politicians who are often men of straw) will be the compassion, sagacity and speed with which these issues are addressed.

(The author (sureshk@emiratesbank.ae) is a General Manager in Emirates Bank Group. The views expressed in this article are not necessarily shared by the Bank.)

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