Despite significant advancements in its economic prowess and future prospects, India’s sovereign ratings have persistently lingered at the bottom tier of the investment grade for an extended period. Hence, when JP Morgan announced last year that it will include India in its widely tracked emerging markets bond index, the word on the street was about an expected upgrade of the country’s credit. Similar excitement surrounds the recent proposal to include India in Bloomberg Emerging Market Local Currency Index. However, the current tussle over handouts gaining steam between political parties to win governance, also being called as the “freebie politics”, may spoil the party for the Indian economy.
According to Indian economists, what has denied the country its rightful recognition among global investors is the existing bias among the rating agencies which create these rankings. One such criticism of these agencies comes from Sanjeev Sanyal, member of the Economic Advisory Council to the Prime Minister, who told Forbes India that around 20 per cent of the weightage in the sovereign rating is driven by subjective indicators of governance and political stability. “As I have pointed out repeatedly in my writings, most of these inputs are generated by Western think-tanks and NGOs that are neither accountable to anyone nor transparent about their methodologies. Indeed, they are usually just the ‘opinions’ of ‘unknown’ experts,” he added.
Bias or not, the significance of these ratings lies in their role as constraining factors for emerging economies, limiting their capacity to attract essential funds. At present, India retains a BBB rating from S&P and Fitch, while Moody’s consistently rates the country at Baa3. This puts the fifth largest economy well behind in the race to attract foreign inflows where ratings on the chart go all the way up to AAA. For its explanation behind the ratings, S&P asserts in a note that its evaluation of sovereign credit hinges on an analysis of institutional, economic, external, fiscal and monetary factors. Such reasons given by these agencies point to the possibility that they may hold down the value of a country’s credit based on its fiscal policies. And the handouts distributed in the name of welfare may instead lead to a downgrade in future.
A Song of Elections and Freebies
The genesis of the current paradigm of freebie politics can be traced back to Arvind Kejriwal’s triumph in Delhi a decade ago, where he successfully ousted the Bharatiya Janata Party (BJP) and dethroned the Indian National Congress. During his election campaign, Kejriwal made big promises to the voters, including the provision of free education, healthcare, electricity and water. These commitments are considered the foundational principles of the Aam Admi Party’s ongoing governance in the capital. While initiatives such as free education and healthcare have garnered praise as welfare measures, contemporary opinions are divided regarding the distribution of free electricity and water.
Yet, the discourse on this matter did not gain national prominence until Prime Minister Narendra Modi’s revdi remark in 2022, when he cautioned voters against electoral freebies. Known as a fiscally conservative leader, Modi had a divergent approach during his tenure as the chief minister of Gujarat, a state with a strong capitalist orientation. There, his emphasis leaned more towards fostering business within the state rather than on welfare. However, recent state assembly polls suggest a significant shift in his stance, where he seemingly aligned himself more with the welfare-oriented policies that he had publicly opposed in 2022.
After his revdi speech, the BJP faced setbacks in the Himachal Pradesh and Karnataka elections, the latter proving to be a significant blow. In an effort to unseat BJP’s Basavaraj Bommai, the Congress made an offer that voters in Karnataka could not refuse. The Congress electoral agenda pledged free electricity, rations and financial aid for women and youth, ultimately swaying the tide in favour of the party. BJP’s reliance on the Uniform Civil Code and the National Register for Citizens faltered in comparison to the offerings put forth by the Congress.
However, as the parties geared up for a more significant showdown for dominion in Rajasthan, Madhya Pradesh, Chhattisgarh, Telangana and Mizoram, the BJP underwent a strategic shift. The party’s manifesto demonstrated a dedicated commitment to the welfare of the people, particularly in Madhya Pradesh and Chhattisgarh. It pledged to establish a minimum support price of Rs 2,700 per quintal for wheat and Rs 3,100 for paddy, surpassing the Congress offering by Rs 100 and Rs 400, respectively, on these commodities in Madhya Pradesh. Additionally, the then chief minister of the state, Shivraj Singh Chouhan, announced an increase in the amount under the Ladli Behena scheme from Rs 1,000 to Rs 1,500, with a further promise to elevate it to Rs 3,000. This extension responded to the Congress’s announcement of the Naari Samman Yojana scheme, which proposed to provide Rs 1,500 per month to one married woman in each household. For Chhattisgarh, the BJP’s promises included the Krishi Unnati Yojana, among other initiatives, to appeal to the voters.
As December commenced, Modi secured a hat-trick with victories in Madhya Pradesh, Rajasthan and Chhattisgarh. These triumphs have given momentum to his party ahead of the 2024 Lok Sabha elections. Yet, the nation’s paramount concern at present revolves around determining who will bear the consequences of these victories, overshadowing the anticipation of the 2024 election outcome.
Economists have frequently criticised the hasty promises made by political parties to garner votes during elections. Following Modi’s response in the recent assembly polls, freebie politics is now in full swing, bringing the implications to the forefront of the debate. Experts highlight specific fiscal challenges in India that require attention, including the escalating debt-to-GSDP (gross state domestic product) ratios of states. According to a report by CRISIL, the debt of states is projected to persist at an elevated level, around 32 per cent of their GSDP. A crucial economic indicator to measure a state’s fiscal health is its debt as a share of GSDP. India as a developing country has increasing borrowing numbers across all its regions and these polled states were no exception.
Sachin Chaturvedi, director general of Research and Information System for Developing Countries, notes that the freebie trend could ultimately result in limited room for capital and other developmental spending. “Domino effect of recourse to such policies in a number of states may eventually weaken the Indian economy so deeply that it may stonewall FDI (Foreign Direct Investment) and diminish national ratings by the global agencies,” he says. As per the data released by the Reserve Bank of India, the debt of states as share of GSDP rose by 12.6 per cent in the period between 2018 and 2023. Meanwhile, FDI inflows to India dropped to 1.47 per cent of the GDP in 2022 from 1.56 per cent in 2018, according to data by United Nations Conference on Trade and Development.
Given the assertion by rating agencies to assess responsible fiscal decisions made by countries in formulating their ratings, the prospect of an upgrade for India seems highly improbable. With the apparent decision by Modi to outdo the opposition parties in their own strategies, it is likely that India will witness further such declarations in the upcoming elections. Experts contend that since a significant portion of voters prioritise tangible benefits that they can receive by electing a particular party, the situation may escalate unless legislative measures clearly delineate between freebies and welfare initiatives.
Lekha Chakraborty, professor at the National Institute of Public Finance and Policy and member of International Institute of Public Finance, says that an informed debate on what exactly can be termed as a freebie is of paramount importance right now. “The role of the state is primarily to provide non-rival and excludable goods, agreed. However, over the years, the government has entered into merit goods territory due to its positive externalities,” she adds. “In the post-pandemic fiscal strategy, emphasis on four components—social security, social infrastructure in education and health, food security and the employers of last resort policy—is crucial. Designing such expenditure within the PFM (public financial management) framework is significant, rather than using these expenditure announcements to incentivise the ‘calculus of consent’ of voters,” she says.
Curious Case of Welfare
The primary justification for these complimentary offerings stems from the citizens’ demand for fundamental necessities in India in return for their tax payments. As per data disclosed by the Central Board of Direct Taxes, direct tax collections witnessed a substantial 160 per cent increase, soaring from Rs 6.4 lakh crore to Rs 16.6 lakh crore between the fiscal years 2013–14 and 2022–23.
However, the Supreme Court, in 2022, noted that despite electoral assurances, taxpayers consistently question the government’s failure to provide essential services. The court emphasised the need to regulate such giveaways. Ahead of last year’s assembly polls, the apex court in October sought responses from Madhya Pradesh and Rajasthan, addressing concerns that public funds were being misappropriated for the provision of irrational freebies. “There may be questions whether these promises are loaded on the balance sheet of a state PSU or they are backed by adequate budgetary provisions or there is some hidden agenda to suddenly withdraw some welfare measures to implement these promises. Even if they work once, the fiscal implications leading to poorer quality of services and duties of a state would surely be debated,” says Chaturvedi.
Amid discussions surrounding the distribution of freebies, one such consequence of financial indiscipline by states came in the form of the Delhi government’s delay in providing funds for infrastructure projects. In December, the Supreme Court voiced its disapproval regarding this delay, emphasising that plans for three out of four projects had already received approval. The court expressed regret that the approval for fund disbursement for these plans was still pending. “There are some sectors where we are not doing well and so I think there is definitely a role for the government to intervene and resolve the issue. But then there is the issue of what a freebie is. There is one example of free electricity. It is definitely a freebie that will create a perverse incentive. It is high time we defined the difference,” says N.R. Bhanumurthy, economist and vice chancellor of Dr B.R. Ambedkar School of Economics.
The elevation of a nation’s credit rating is not intended to be an instantaneous outcome of its incorporation into a global index. Instead, it is a gradual and indirect consequence. Likewise, the same holds true for the influence of fiscal decisions on these ratings. While the announcement of India’s inclusion in the JP Morgan index was a noteworthy moment for the country’s debt market, its true impact on the economy still holds to be a matter of debate due to this tussle over freebies.