Post interim budget, the threat of a downgrade remains

On February 28, 2013, finance minister P Chidambaram presented the budget for the period April 2013 to March 2014. In this, he projected a fiscal deficit of Rs 5,42,499 crore or 4.8% of the gross domestic product (GDP). Fiscal deficit is the difference between what a government earns and what it spends, expressed as a percentage of GDP.

All through the year, Chidambaram maintained that come what may the government won't cross the fiscal deficit of 4.8% of the GDP. In the end, he stood by his promise, but only on paper. The fiscal deficit for 2013-2014 is now estimated to be at Rs 5,24,439 crore or 4.6% of GDP.

It was important that the government did not cross the target of 4.8% of GDP that it had set, given the threat of a downgrade from international rating agencies.

Ratings agency Standard and Poor's (S&P) currently rates India as BBB-, the lowest rating in the investment grade. If India were to be downgraded, its rating would fall to BB or the first stage of the junk status.

This would mean that a lot of foreign investors would have to sell out of the Indian bond market as well as the Indian stock market, given that they are not allowed to invest in countries with a junk rating. This would lead to huge pressure on the rupee as foreign investors cashing out will convert their rupees into dollars.

In fact, in November 2013, S&P had maintained the "negative" outlook on India. This meant that there were chances of a downgrade over the next 12 months. As the ratings agency had said in a release: "The central government's budget balance (that is, the fiscal deficit), however, tells only part of the Indian fiscal story. Using a broader measure of general government deficits, we project a 7.2% of GDP deficit for fiscal 2014, to which one should add 1-2 percentage points of GDP deficits for the unprofitable portions of the consolidated public sector, including state electricity boards and oil-marketing companies."

Keeping this definition of fiscal deficit in mind, how has Chidambaram done? It is safe to say that the fiscal deficit of 4.6% of GDP is at best a hogwash. In order to arrive at that number, the finance minister has under-budgeted for petroleum, food and fertiliser subsidies in a major way. Estimates suggest that payment of more than Rs 1,20,000 crore worth of subsidies has been postponed to the next year.

Take the case of petroleum subsidies. Chidambaram had budgeted Rs 65,000 crore towards them. The number has now been increased to Rs 85,480 crore. Of this amount, a substantial chunk has gone towards payments of petroleum subsidies that should have been paid between April 2012 and March 2013 but were postponed to 2013-2014.

In fact, data released by the Ministry of Petroleum and Natural Gas in early February shows that the oil marketing companies have reported under-recoveries of a total of Rs 1,00,632 crore during the first nine months (April-December) of 2013-14 on the sale of diesel, PDS kerosene and cooking gas. Hence, the Rs 85,480 crore budgeted towards oil subsides is clearly not enough.

On the earnings side, Chidambaram has indulged in massive asset-stripping to match his numbers. He has forced public sector banks, which are in a financially fragile state, to pay interim dividends of close to Rs 27,000 crore. ONGC and Oil India have been forced to pick up shares worth Rs 5,000 crore in the loss-making Indian Oil Corporation, a company which no private investor wants to touch. And the government has also managed to get more than Rs 19,000 crore from Coal India, as dividend and dividend distribution tax.

Anyone who understands some basic accounting will tell you that using assets to pay for regular expenditure is never a great idea. Ratings agencies like S&P obviously understand this. And that is why it had said in November 2013 that using broader measures, the fiscal deficit comes to greater than 7.2% of GDP. In that sense, the deficit of the government is clearly greater than the 4.6% of GDP that it has arrived at, once the accounting shenanigans are taken into account.

Given that, the threat of a downgrade remains. As S&P had said in November, "We expect to review the rating on India after the next general elections when the new government has announced its policy agenda."

The agency plans to look at the fiscal policy of the next government as well, among other things. Given the mess the current fiscal policy is in, it will be very difficult for the next government to do much about it. The only way out is to slash government expenditure massively. And that is easier said than done.

The writer is the author of Easy Money. He can be reached at vivek.kaul@gmail.com