No. 53, May 2013

No. 53
(May 2013):

Why Do Credit Rating Agencies Press India to Reduce Government Spending?

Last October, the credit rating agency Standard and Poor (S&P) threatened to downgrade the status of India’s debt to “junk” grade if “fiscal reforms slow”. The Finance Minister keeps citing such warnings to justify his spending cuts. Why do foreign institutional investors (FIIs) put such pressure on the Indian government to curb spending? Why do credit rating agencies issue dire warnings of a rating downgrade if the Government fails to bring down the fiscal deficit at the pace they demand? Is it because they are worried that the Government will not be able to service its debts?

As we point out in "The 'Fiscal Deficit' Bogeyman and His Uses", they can hardly be under such an impression: IMF projections show that India’s Government debt/GDP ratio and interest payments/GDP ratio are going down, and will continue to do so in the next few years. However, this has not deterred S&P and the FIIs from raising repeated alarms about the ‘sustainability’ of India’s government debt.

The credit rating agencies and the FIIs also claim that they want the fiscal deficit reduced because it fuels “excess demand”, leading to a worsening current account deficit.[1] The implication is that the resulting scarcity of foreign exchange will make it difficult for the Government to service its foreign borrowings; hence the threatened downgrade of India’s international credit rating.

However, to ascribe the worsening of the current account deficit[2] to the fiscal deficit is not borne out by the facts. First, in the middle of an industrial recession it makes no sense to talk of “excess demand” in the economy as a whole. It is because of lack of demand that industrial growth has slowed. The growth of private final consumption expenditure has halved in 2012-13; government final consumption expenditure has more than halved.

Secondly, despite the industrial recession and fall in GDP growth, imports remain very high. One reason for this is that demand for some commodities, such as oil, is ‘inelastic’, i.e., demand does not change much with a change in price.[3] Moreover, consumption by the top section of Indian society is not affected as much by the recession, and this consumption is highly import-intensive. Gold imports, driven by speculative investors, rose by almost half in 2011-12, and net gold imports (3 per cent of GDP) accounted for most of the current account deficit (4.2 per cent of GDP). We should note that, while FIIs oppose (domestic) fiscal deficits on the ground that they lead to (external) current account deficits, the same FIIs vehemently oppose any measure aimed at directly reducing the current account deficit by restricting imports (e.g., physical restrictions or customs duty increases aimed at deterring undesirable imports). They also oppose any measures to raise direct taxes, which would reduce the fiscal deficit without reducing expenditure.

At any rate, this year we have been given a live test of the FIIs’ theory: The fiscal deficit has been cut in 2012-13 over the previous year; but the current account deficit is running at an even higher percentage of GDP than last year.

If these claims of FIIs and credit ratings agencies are untenable, why do they nevertheless press them with such insistence and threats? Is it merely because they are under the spell of some mistaken economic theory? No doubt, the owners of capital do believe the theories their intellectuals think up. But generally these theories objectively suit the interests of the owners of capital. So it is useful to look at the objective interests being served by these theories (irrespective of the consciousness of those espousing these theories).

In general, of course, big capitalists want clear limits on certain types of State intervention in the economy. If it is explicit in practice that State action can directly increase investment and employment in the economy, the people might demand such State action, and might question why the State instead keeps trying to please the capitalists with all sorts of concessions and bonuses in order to persuade them to invest. Hence capitalists try to rule out the germination of any such idea by in advance creating a panic about the ‘unsustainability’ of State spending.

Gaining from distress

But further, there is an immediate reason why international financial investors are opposed to any increases in Government spending. Which is that they can actually benefit from keeping the Government starved of funds. When Governments are required to cut spending, and consequently starve developmental and infrastructural activities of funds, the paucity of funds becomes an argument for various types of privatisation: For example, the privatisation of Government firms, selling shares in public sector firms, promoting ‘public-private partnerships’ on terms very favourable to private investors, hawking off valuable national natural assets such as mines, opening sectors of the economy hitherto closed to private/foreign capital, and the like – are all steps undertaken by cash-strapped governments to generate funds. All these changes create opportunities for private investors to make financial bonanzas. A staggering amount of mineral wealth has in fact been gifted to the corporate sector on the phony ground that the State did not have the resources to develop it. The Government has been desperately showering gifts on the private sector in an effort to get them to invest in infrastructure. In all of this international finance gets a share of the cream.

Or take the food subsidy: In 2002, the High-Level Committee on Long Term Grain Policy “had to take note of an opinion that the existing system need not be salvaged and that the present crisis may in fact be an opportunity to do away not only with Minimum Support Prices (MSP) but also with the Public Distribution System (PDS), and restrict the role of the Food Corporation of India (FCI) to maintaining a reduced level of buffer stocks.” (emphasis added) Representatives of multinational grain companies had told the Committee that they would not make large investments in grain trading in India unless “the potential threat posed by high stock levels is removed”. By “high stock levels” they meant, not the present grain mountain with the FCI, but the long-standing norms for how much minimum buffer stock should be maintained. The multinationals wanted those norms reduced drastically. They argued that the FCI maintaining enough stocks to control excessive rise in consumer prices would pose a “potential threat” to the profits of multinational grain trade. (Equally, FCI procurement from peasants prevents farmgate prices from falling too low, which would impoverish peasants and harm future food production; such intervention by the FCI, too, restrains the multinationals’ profits). If, on the other hand, only a small buffer stock were maintained, it would suffice only to tide over very temporary shortages and emergencies. When the Government required substantial quantities, it would have to import from the multinational companies which control the international grain trade, rendering any price intervention by the Government near-impossible. In this light, the decision to move to a system of cash transfers instead of the existing system of procurement-FCI-public distribution is a privatisation of enormous implications.

In a more extreme situation, when a country’s economy contracts as a result of fiscal ‘austerity’, the national assets of that country become cheaper for foreigners to buy up; when the economy eventually revives the foreign investors will have made a killing. This is not mere conjecture: In 1997, when Southeast Asian economies went into a crisis in 1997 and were forced to take loans from the International Monetary Fund (IMF), the IMF imposed economic policies that led to the contraction of their economies and the opening up of new sectors to foreign investment. Foreign investors promptly snapped up assets on the cheap in the IMF-afflicted countries. There are several more recent examples. As a condition of receiving loans, Greece is currently being forced to sell off state assets worth 10 billion euros by 2015, and 50 billion euros by 2022. “About 15 percent of the portfolio [of assets to be sold by the Greek agency for privatisation] is stakes in banks and utilities, as well as the national lottery. Approximately 30 percent comprises ports, airports, motorways and other infrastructure. The vast remainder consists of real estate — from a former royal palace to the Athens police headquarters — and prime cuts of land. These include beaches on the vacation playgrounds of Rhodes and Corfu.”[4] At the end of this process, it is projected that Greece’s debt will be reduced by one per cent. Unsurprisingly, this process is meeting with resistance from the Greek people.

Opportunities for foreign investors

A similar process is underway in India. In January 2013, Finance Minister Chidambaram went on a ‘road show’ of Singapore, Hong Kong, London and Frankfurt to market the Indian economy to foreign financial capital. The theme of his presentation was “Why Global Investors Should Invest in India.” A major theme of his sales pitch was, of course, that the fiscal deficit was being brought down, and would sink to 3 per cent of GDP by 2016-17. Under the heading “Opportunity to Reap High Yields”, the following table is presented of the “Top 10 public sector units by realizable value”. The “potential realizable value” is $51 billion. It does not clarify whether the “high yields” are to be reaped by the Government, or by private investors. However, the record of disinvestment in public sector units has been that it is the private investors who reap the yields of a crop grown with public money.


As we have pointed out earlier,[5] virtually all partial disinvestment of shares in public sector firms has been carried out consciously at prices which are ‘attractive’ to investors, namely, at prices which yield investors a bonanza. This was deemed to be necessary to ensure the ‘success’ of privatisation. As a result, from the very first disinvestment, these sales have attracted wide criticism, including from the Comptroller and Auditor General (CAG). Gross irregularities in the very first round (1991-92) allowed a handful of buyers to depress prices to below the reserve price set; the CAG put the loss at Rs 3,442 crore on receipts of just Rs 3,038 crore. Going again by the need to ensure the ‘success’ of the disinvestment, only shares of profitable public sector units have been sold. The largest bonanza took place in March 2004, during the last days of the National Democratic Alliance (NDA) regime, when the Government earned Rs 15,332 crore from the hurried sale of shares of six firms, including the hugely profitable Oil and Natural Gas Corporation (ONGC). The Disinvestment Minister admitted that shares were being sold at a discount, but said “There’s very little that we can do as the disinvestment proceeds are required by [the Finance Ministry] by the end of the current fiscal to arrive at the magic figure of the fisc.”[6] The Minister also acknowledged with disarming candour that market manipulators had driven down prices of public sector shares in the days before disinvestment, in order to pick up the disinvested shares at low prices. When asked who the manipulators were, the minister said, “I have told them not to reveal. They realised what they were doing was not right.” He implied that some of the financial advisors to the disinvestment were themselves involved. However, he ruled out punishing them: “Punishing will lead to the collapse of the share market.”[7]

Even the aggressively anti-fiscal deficit, pro-privatisation Kelkar Committee on Roadmap for Fiscal Consolidation remarked in September 2012 that “On the disinvestment side, it would be extremely difficult for the Government to move ahead with its disinvestment programme [during 2012-13], given the subdued equity market conditions.” Shares of public sector units have been at particularly depressed levels. In many of these firms, the percentage of shares available for trading is still small (with most of the shares still held by the Government), and so it is relatively easy for market manipulators to drive down the price in anticipation of a major disinvestment by the Government.

Nevertheless, the Government managed to raise roughly Rs 24,000 crore in 2012-13, simply by selling at depressed prices. At the tail end of 2012-13, the Government sold shares of Nalco, the country’s largest aluminum producer, with rich mines of its own, at Rs 40 per share. At the time, the firm’s cash balances alone were Rs 19 per share. Similarly, the steel ministry reportedly opposed the disinvestment of Steel Authority of India Ltd (SAIL), particularly as the market was in a slump and the shares would have to be sold cheap. SAIL’s market capitalisation (i.e., the current share price times the number of shares) had fallen from Rs 1.58 lakh crore in April 2010 to Rs 26,869 crore[8]; indeed, it lost 35 per cent of its market capitalisation since January 2013 itself – “knowledge that a big supply of shares from the Government was on the anvil did not help the stock, hit anyway by a cyclical downturn in the sector.”[9] Finally, despite the ministry’s resistance, the Government went ahead with the disinvestment of 5.82 per cent of the shares. One newspaper commented that “the good part is that the fall in share prices has made valuations attractive” [10] to private investors.

Despite the Kelkar Committee recommending disinvestment of Rs 30,000 crore each year in the next two years, the Government has now budgeted to achieve Rs 54,000 crore, or about $10 billion, in 2013-14 itself. Because it is under special pressure to bridge the fiscal deficit and to attract foreign capital, and because the stock market is not buoyant, the Government will find it very difficult to raise such a large, indeed unprecedented sum. In order to succeed, it would have to sell at very depressed prices indeed.

However, the attractions for foreign and domestic private investors are not limited to picking up shares of public sector units. Under the heading “Opportunities in the infrastructure sector”, the Finance Minister’s presentation to FIIs explains: “12th Plan envisages investment of US $1 trillion on infrastructure projects; half of it from the private sector.” This includes dedicated railway freight corridors; the Delhi-Mumbai Industrial Corridor (containing nine mega-industrial zones of about 200-250 sq. km; a six-lane intersection-free expressway; and a 4,000 MW power plant); urban infrastructure (including metro rail projects in major cities in various stages of implementation); highways; 88,000 MW of electricity generation capacity; and so on. In this context it advertises that “India has launched a unique framework for financing its infrastructural needs”, the Infrastructure Development Funds, potential investors in which may include “risk-averse offshore institutional investors, off-shore HNIs [High Networth Individuals], and Non-Resident Indians”, beside domestic investors. Among the attractive features are special tax concessions.

Perhaps inspired by Greece’s example, the Kelkar Committee recommends selling Government land to private investors: “Over the next 24-36 months, there is yet another policy instrument for raising resources for development and that is monetizing government’s unutilized and under-utilized land resources. These resources can finance infrastructure needs particularly in urban areas. For monetizing land resources, the potential is considerable given the under-utilized prime lands of PSU’s, Port Trusts, Railways, etc.”

None of this guarantees that FII capital will in fact come to India; that depends, as our ministers have been making sure to tell us, on other factors as well, particularly the global economic situation. However, the pressure on the fiscal deficit ensures that, whether or not they get picked, the pickings are rich.



[1] The current account is the broadest measure of current external transactions. It includes all our exports of goods and services minus our imports of goods and services. It also includes earnings on Indian investment abroad minus payments India makes to foreigners on their investment in India. And finally, it includes cash transfers, such as are sent by Indian workers in the Gulf. When a country runs a current account deficit, i.e., paying out more than it receives, the gap must be bridged either with inflows of capital (foreign direct investment, foreign investment in the share markets, or foreign loans), or a reduction in the country’s reserves of foreign exchange. (back)

[2] When a country runs a current account surplus, it has surplus savings; when it runs a current account deficit, it is drawing on another country’s savings. The current account deficit is thus also, by definition, a measure of how much of a country’s investment is funded by foreign savings. However, that simple identity does not explain provide an explanation for what causes the current account deficit, i.e., it does not mean that a rise in Government borrowing causes a rise in the current account deficit. For example, if the Government were to restrict unproductive imports and ration necessary imports such as oil, it could force a decline in the current account deficit. In that case, any rise in Government borrowings would result in a rise in domestic private savings. (back)

[3] Demand for oil can only be reduced in a major way with a planned change in the pattern of consumption and the economy as a whole. (back)

[4] “Privatising Greece, Slowly but Not Surely”, New York Times, 12/11/12, (back)

[5] See Aspects no. 45. (back)

[6] Quoted in C.P. Chandrashekhar, “To the market this March”, Frontline, 26/3/04. (back)

[7] Outlook, 22/3/04. (back)

[8]“SAIL pricing kept under wraps, issue size cut”, Business Standard, 21/3/13. (back)

[9] “Jinxed SAIL sale to take divestments to new high”, Business Standard, 21/3/13. (back)

[10]“SAIL crosses offer-for-sale hurdle, valuations attractive”, Business Standard, 22/3/13. (back)

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