In the last week of April I was in India around the time credit rating agency Standard & Poor's decided to cut the country's rating outlook.

While in India I spent most of my time in a hospital with my ailing mother who took a different type of cut. Suffering from diabetes related gangrene, she had to undergo an amputation of one of her toes.

Despite the loss of a toe, the lady was in good spirits. Together, we killed time watching TV soaps. One evening, irritated by the intermittent power cuts, she let out her frustration and said, "This country is going nowhere."

When the power supply was restored, I saw on the television screen an economist from a Delhi think-tank almost repeating her sentence.

"Despite more than two decades of reforms, it looks like our economy is heading back to where it was in 1991," he said.

No doubt, India, which became the darling of emerging market investors over the last two decades, is facing some kind of crisis of confidence from within and outside. A sharp increase in the country's fiscal deficit and a yawning current account deficit has raised fears that the country could soon face low investment growth and a potential capital flight. The widening trade deficit, sticky inflation and declining currency have added to the country's litany of worries.

A quick look at the key economic data suggests that the anguish expressed by S&P, the economist and my mother have somewhat the same common denominator.

Fiscal deficit

In 1991 when the Government of India began its economic reforms the country's fiscal deficit was 7 per cent of gross domestic product (GDP). After two decades of reforms the deficit for last year was estimated at 5.9 per cent of GDP.

Suddenly everyone is saying India is afflicted by deficits of all sorts. While the current account and fiscal deficits are the twin villains economists often blame for the country's econ-omic woes, there are more than half a dozen new varieties of deficit such as policy deficit, credibility deficit, integrity deficit, governance deficit, vision deficit and more that have crept into the daily financial lingua of the country.

The latest Federal budget pledged to reduce country's fiscal deficit to 5.1 per cent of GDP in the next fiscal year from 5.9 per cent this year. Analysts say India's GDP growth potential depends crucially on the outlook for investment growth.

In the last four years, real investment growth has been lacklustre, averaging 6 per cent per annum compared to an average of 16 per cent per annum during 2004-07. If investment continues at its current rate, then India's potential growth could slip below 7 per cent, Nomura Securities warned in a recent report.

While the growth outlook is looking bleak, the virtual policy inaction and a negative credit outlook by S&P have spooked the financial markets. In fact after S&P's move, FIIs withdrew nearly Rs13 billion from the stock market last week. Both the Sensex and the Nifty fell by two per cent last Friday.

Rating downgrade

Although India has no sovereign global bond issues, a rating downgrade would increase borrowing costs for local companies and make it harder to refinance debt.

The prospect of a downgrade had chilling effect on foreign investor confidence in the country.

Experts also blame the recent FII outflow to a host of other factors, including the government's anti-tax avoidance rule (GAAR) proposal announced in the last budget. The rule gives a wide range of discretionary powers to the tax department and has introduced huge unpredictability in the future tax burden on FIIs.

Analysts say the high cost of doing business and continued domestic policy uncertainties could result in capital flight and eventual brain drain.

With weakening fundamentals getting reflected in the financial markets, the government needs to act fast.

Without implementing reforms to attract foreign investments, the current account deficit will continue to swell and inflation will remain high. This would leave the central bank with little elbow room to lower interest rates.

If a lot of people out there, including my octogenarian mom, think the economy is heading nowhere, no one can blame the foreign bulls if they decide to herd out of the Indian market.