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In May 2024, S &P Global raised India’s rating outlook from “Stable” to “Positive” on account of the strong economic fundamentals of the country but maintained the sovereign rating at “BBB". However, S & P may upgrade India’s rating, if it reduces fiscal deficit to less than 7% of the GDP on a structural basis and sees a sustained and effective monetary policy reducing inflation on a durable basis. The corollary to that is also that the rating outlook may get downgraded to “stable” from “positive” on account of poor fiscal and inflation management by the government and the banking regulator respectively.
One of the key fundamental aspects underpinning fiscal responsibility is the political will towards maintaining a fiscal discipline. Given that the incumbent government got a third term under a coalition route, sovereign rating agencies are closely monitoring the government spending plans and taking cues on commitment towards fiscal discipline. Improved sovereign ratings invariably result in the country becoming a preferred area of investment, raising the demand for all investable asset classes in the country.
This translates into higher capital flows for the country in the form of sustainable investments like Foreign Direct Investment into the country. This will also push yields down and thereby reduce the cost of capital and spur more investments in the process.
Let us now understand the plans of the government from a fiscal deficit standpoint. The government plans to bring down the fiscal deficit for FY 2024-25 to 5.1% of GDP. Some experts from rating agencies expect the fiscal deficit percentage to land up at 4.5% of GDP for FY 2025-26. Given that there was a record transfer of surplus dividend from RBI to the government this year to the tune of INR 2.11 Lakh crore, this year’s fiscal deficit glad path seems to be achievable. However, the sustainability of the same in the future depends on how the budget is going to balance capital expenditure and social spending.
Capital expenditure is important as the same ensures sustainable development of the country. The government should continue with its focus on agriculture, infrastructure, rural empowerment, women empowerment, and market infrastructure institutions focus to ensure that the throughout generated from the real economy is powered well by the financial services ecosystem. Social spending is important to balance the negative effects of capitalism which largely stems on account of the structural inequality that it creates. However, the government should consider focusing on the long-term nature of social spending such as social security schemes around housing, employment, pension, and retirement, especially in the rural areas where there is a need for the same, rather than the short-term focus on subsidies or freebies.
Another area of focus from a revenue standpoint should be to increase tax collections as well as revenue from divestments. The government should consciously focus on proposals around divestments and increase the thrust and focus on the same, given that many times the target for divestments are missed either on account of lack of market interest or regulatory delays. Divestments will help bring greater efficiency in resource management by the government and thereby efficient allocation of the resources as well.
Some reforms that the finance ministry may consider, that could help attract more capital and thereby help in the fiscal consolidation process could be – liberalization of FDI norms within financial services, especially public sector banks, focused consolidation plan for the co-operative banks ecosystem in the country (this could potentially free up a lot of capital and hence facilitate better allocation of resources), risk based capital structure for the insurance industry – to name a few. Last but not the least, the government should continue to focus on taking the India Digital Stack to the world as this will greatly reduce the frictions within the global financial supply chains, on account of the current geo-political crisis – West Asian crisis, Ukraine conflict, Sino-American cold relations - that does not seem to have an end date in mind.
The government would need to show a lot of innovation in balancing the interests of its coalition partners in ways that are credit positive from a sovereign rating agency standpoint. This is not an easy journey, but a necessary one to ensure that we continue to be on the trajectory of growth that the government had envisioned for the country over the journey of the past decade.