Fitch Report on Public Finances

Our Banking Bureau
23 February 2005

However, says the international rating agency, Fitch Ratings, in a study on public finances, in its opinion higher growth and general macroeconomic stability are not reasons for complacency and delaying fiscal reforms. In fact, cyclical and some structural factors may have been partly responsible for the favourable macroeconomic environment despite large fiscal imbalances.

For example, the study notes, the link between inflation and the fiscal deficit may have been broken, as the practice of monetising the deficit has been abolished. Also, the global disinflationary environment, increased progress on trade liberalization and ample stocks of food grains may have dampened inflation over the last few years.

Similarly, until quite recently, the upward pressure on interest rates had been avoided.

Indeed, the government has been quite successful at increasing the average maturity of its domestic debt as well as reducing the average yield. Some of the decline in interest rates over the last three years is probably attributable to ample liquidity amid slack credit demand, resulting in the banks holding a larger proportion of their deposits in government securities. However, with the recent upturn in the global and domestic interest cycles — local interest rates have risen by 50-100 basis points over the past six months — and more importantly, the pick-up in domestic activity, competition for domestic savings to finance the fiscal deficit will increase.

Although growth has remained resilient despite large fiscal imbalances, in Fitch's opinion, India's ability to grow at over 8 per cent per year on a sustained basis is being undermined by chronically weak public finances, which lead to the pre-emption of scarce resources by the public sector. The inflexibility of public finances makes it difficult for the government to spend on infrastructure such as roads, ports and energy, which can greatly benefit the private sector.