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Chidambaram: India?s finance
minister notes that ?if economic
growth happens, everything else
will fall into place?
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The national elections held in May have cast a shadow on India's shining economic story. Foreign investors are reassessing growth prospects now that the Congress Party, which relies on communist allies, has taken over.
A jump in the annual inflation rate to 5.5% in early June caused bond yields to rise to a one-year high, and the rupee slid as foreign portfolio investors sold over $700 million in the six weeks from May. Those investors had pumped a record $7 billion into the Indian stock market last year and a further $4 billion in the four months to April this year.
Coalition governments are not new to India. Nor is there any reason to suspect the economic reform credentials of the Congress Party, which started India's economic reforms in the early 1990s. But foreign investors are painfully aware of the changes in direction that economic policy can take when allies inside and outside the coalition set out to thwart or slow the pace of reform.
Bankers fear that the politics of appeasement will win. ?The worry is that the government will not take the hard decisions needed to cut the fiscal deficit, which is over 10% of GDP, and this will slow economic growth,? says Udayan Bose, head of Lazard in India.
S&P revised its outlook on India's foreign currency BB rating to stable last year on an improved external payments position but says India's domestic debt is way too high at nearly 90% of GDP. ?The Congress Party has promised higher growth and we expect some sort of reforms to continue. Just how much the coalition partners dilute the focus on reform and reduce its pace will have to be watched. The fiscal situation is the main constraint on growth,? says Ping Chew, head of emerging Asia sovereign ratings at Standard & Poor's.
Early signals from the new United Progressive Alliance government are not encouraging.
Finance minister Palaniappan Chidambaram has ruled out the privatization of profitable state companies, including the state banks, but said that their managers would be given greater autonomy.
Banks have been told to increase new farm loans by 30% this fiscal year, and to restructure old ones. AK Purwar, chairman of State Bank of India, says his bank's profits will not be hurt by increasing loans to the farm sector but concedes that around 8% of existing farm loans are non-performing, a level higher than in other sectors.
The new government's mandate is to raise the annual economic growth rate to 7% to 8% of GDP, and that will require reform, Chidambaram told reporters soon after taking over: ?If growth happens, everything else falls into place.? The government promises more jobs and higher spending on health, education and infrastructure. What worries investors is how the government proposes to fund that spending, particularly since privatization of state assets has been ruled out. Higher taxes or a wider budget deficit could slow the growth momentum.
Not everyone is pessimistic, though. ?We see a pick-up in investment demand. India has reached the inflection point that China did a decade back, of over $500 annual per capita income, that will lead to higher levels of consumption and basic infrastructure,? says KV Kamath, chairman and managing director at ICICI, India's largest private bank.
Cheaper loans and higher spending in the rural sector could also boost companies that sell tractors, motorcycles and cars.
The challenge before Chidambaram is to stem the outflow of capital and confidence while satisfying the demands of the left-leaning coalition.
The good news is that no two politicians measure up to that task better than Chidambaram and prime minister Manmohan Singh ? an economist and former finance minister.