Of debts, downgrades and politicians in delusion

Last week, a tectonic plate shifted. For the first time since 1917, the US was downgraded from AAA to AA by Standard & Poor. The quake may have been located across the Atlantic Ocean but it signals a tsunami warning for the world. The aftershocks have rocked stock, commodities and currency markets. The riots in London have rattled regimes across Europe struggling to contain the contagion of debt. The threats of political crises and possible downgrade from AAA status are new variables. It is not just borrowers who are under fire. Lenders too are feeling the heat. The hammering of bank stocks—Citibank, BofA, SocGen who hold sovereign bonds —is illustrative of the fragility of the global architecture.

As with the geological avatar, the tidal effects of this eco-quake are bound to impact the Indian economy. You would imagine an event of this magnitude would provoke a discussion in Parliament. No. The temple of democracy was too engrossed in staging the theatre of the absurd. There was no debate, no discussion and even the one zero-hour mention was a caricature of political thought. If the political parties believe this is not an event worth their attention, then we need no further proof that our desi politicians are dwelling in delusion.

Just do the math. The total income of the world is roughly $63 trillion (WB/2010). The US accounts for 25 per cent or $14.5 trillion. The European Union accounts for $16 trillion and Japan $5 trillion. The US has to raise an additional $2 trillion to keep its systems running; simmering politics threatens to unravel any plan the EU might concoct to manage the debt contagion; and Japan has been struggling even before Fukushima. Juxtapose this into a business equation. The US, the largest consumer, is struck by what is described as a liquidity or cash flow problem. The EU has a solvency problem; four of its members are bankrupt. Do the arithmetic and you realise that between them, the US, EU and Japan add up to $35-plus trillion or 60 per cent of global GDP. In short, the three largest consumers in the global economy who account for more than half the global GDP are in deep trouble.

Momentum in physics or economics is the outcome of mass into velocity. If 60 per cent of the mass is decelerating, can India be unaffected? The US owes foreigners $4.5 trillion—four times India’s national income. Debt is now a four-letter word. The crisis of debt is the consequence of living beyond means. Not unlike India. Government borrowings have shot up five times to Rs 417,128 crore in seven years, of which Rs 267,986 crore goes to pay interest. The political class has legitimised the funding of private political ambition with public resources in the name of alleviating poverty. Every day, the government borrows around Rs 1,100 crore of which over Rs 700 crore goes in interest costs.

If India has managed to stay out of trouble, it is explained by a unique situation. Unlike the EU economies and the US, the government of India borrows from Indian savings. But savings require growth. The slowdown in the economy is the price for political profligacy. Thanks to inflation, the RBI has hiked policy rates 11 times since January 2010. Interest rates—yesterday HDFC Bank hiked PLR to 18.5 per cent—are higher than they were in 1996. And the stress of high interest costs is visiting the balance sheet of banks. Earlier this month, ICICI had to take a stake in a debt-laden telecom outfit. On Monday, rating agency Moody’s took a negative view on the exposure of public sector banks—SBI, PNB, BoB, BoI, IDBI, OCB—to Air India which is losing around Rs 25 crore a day. And we are yet to ascertain the impact of the crisis on companies who borrowed in dollars to acquire overseas assets betting on the India Story.

India Inc is overleveraged in hope and could be laid low by political failure. It is estimated that over $33 billion worth of shares are pledged with banks as collateral by promoters. S&P’s Indian arm Crisil has reported defaults by 43 companies between April and June, and expects more defaults and downgrades ahead. And these are symptoms of a larger malaise. Very simply, both the government and private sector are over-leveraged which will unravel rapidly in a crisis.

The Indian political class and policy wonks are sanguine in their assessment of an India insulated from the fire in the prairie. They would do well to recall that GDP growth dropped to 5.4 per cent from 9.3 (YoY) after the crash of 2008. It is true that India is largely a domestic economy and exports account for just 20 per cent of GDP. But it is also true that India doesn’t export enough to pay for its imports. If it wasn’t for the remittances, India could have been knocking at the doors of lenders. A global slowdown will hit India. Sure, the fall in prices of commodities will help but the advantage accrues only if output and consumption grow. Yes, any assessment must factor the positives of domestic market and the demographic dividend. But domestic consumption is not a given. It requires growth in investment, job creation and incomes, ergo demography is not destiny.

It is entirely possible that the unity of purpose which defines the political economies of the West will gather force, unleash another round of fiscal stimulus to engineer growth. Keynesian economics could be re-resurrected. India can yet convert the challenge into an opportunity. Money chases returns and India has the size and potential to deliver it if the cobwebs of political sloth that shackle the economy are cleared, if the case by suitcase paradigm is dismantled. But the political class will need to shift focus from personal ambition to public aspirations. Demography could yet deliver India its long promised tryst with destiny.

Shankkar Aiyar, senior journalist on sabbatical, specialises in

the politics of economics