Why the ~20 trillion will support our sovereign rating

The need of the hour is proper design and implementation

As India completes the third edition of the lockdown and the prime minister and the finance minister announce a ~20 trillion cumulative package, a few things are apparent. First, India did the right thing by enforcing the lockdown. A logical corollary is the dilemma that we are facing in making an informed exit. We believe with proper design and implementation, the ~20 trillion package can strongly support our sovereign ratings, even though India has limited fiscal space.

First, the administrative part. Contrary to public perception, India has tested 2.03 million samples, more than Canada and France and almost as many as the UK. At this rate, India is likely to test more than that by Spain and match Italy and Germany by the month-end. India touched 64,000 cases on Day 101, while most other countries touched the figure between Day 50 and 70. Critics may argue that India is testing less per million, but then confirmed cases and deaths are still among the lowest, suggesting successful containment.

It is also surprising that no one is quoting the official data that shows of the 42 million Indians infected by the highly infectious respiratory disease in 2018, only 3,740 died! Clearly, Indians have long developed herd immunity and there is no reason why we can’t beat the current crisis. Finally, we must be proud that states like Kerala and Karnataka that took aggressive action early on, helped limit the spread.

Now the second part. If we compare globally, at 4 per cent of GDP, the size of India’s package (excluding off-balance sheet) is more than twice the average size announced by other economies. It is remarkably similar in terms of composition — with payroll support in a quarter of the stimulus packages across developed and developing countries, and infrastructure spending almost completely missing. Four per cent of GDP implies a fiscal support of ~8 trillion, excluding guarantees and monetary policy support. The additional government borrowing is ~4.2 trillion and from the FM’S announcements it appears that the extent of direct fiscal support will now be possibly within that limit.

Also, it has been repeatedly emphasised that a fiscal package should be directly equivalent to tax/gdp ratio and hence India should have refrained from fiscal expansion. A close look at the table, “Fiscal stimulus by select economies” shows that India’s cumulative package now matches countries with similar ratings, similar tax/gdp ratio and with a much higher/lower per capita income.

Most importantly, India must look at the experience of other South Asian economies that had witnessed a sovereign ratings downgrade during the crisis not because of a large fiscal slippage but because of a growth slippage. A critical factor determining a country’s maximum sustainable debt level is the difference between its future nominal interest and growth rates. This interest-growth differential determines the rate at which a country’s government debt rises relative to its output. A higher interest-growth differential means that a country must raise larger surpluses to stabilise its debt-gdp ratio. India’s quarterly average interestgrowth differential (for the period FY13 to FY20) has been rising since Q1 FY19. In the current situation, both the key interest rate and GDP are expected to fall further and thus the difference between interest rate and nominal growth rate will be positive. In that case, we will land up in unsustainable debt and we must avoid that.

India has had one net rating upgrade by S&P in the last 28 years. While this statistic conveys the status of India’s fiscal (though not correctly), it does not honestly convey the intricacies of sovereign ratings. As The Economist points out “what, for instance, to make of America’s Treasury borrowing a record $3trn this quarter? And what would justify cutting Italy’s rating to junk?”. Unfortunately, post the global financial crisis, the dependence on ratings in decision making and regulation has significantly increased and that discourages analysts from doing a proper exercise, India being no exception. We are thus absolutely correct in giving importance to our domestic considerations rather than to rating agencies.

Two things before we end: First, there are several options to finance increased government expenditure. Second, we must also praise the state governments for unleashing ~1.7 trillion. The Centre and the states have launched several good schemes over the years to support the vulnerable. Take the nationwide portability of ration cards under the National Food Security Act, 2013, which helps those entitled to it to lift food grains from any FPS without obtaining a new ration card. To prevent migrant workers from fleeing cities in the wake of coronavirus, the Karnataka government has launched this initiative across all districts. The need of the hour is proper implementation of such pre-existing schemes to benefit our migrant population as has now been announced by the FM.