Indian budget injects life into economy


Anuj Gangahar, Matthew Turner
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Analysts upbeat; fiscal commitment impresses.

Indian finance minister Palaniappan Chidambaram. The budget was credit positive.
Indian finance minister Palaniappan Chidambaram. The budget was credit positive
India’s budget offers real scope for narrowing the budget deficit and is credit positive for the sovereign, according to analysts.

In a last-ditch attempt to boost economic growth before the next general election, the government has committed itself to targeting a budget deficit of 4.8% of GDP in 2014, achieving nominal GDP growth of 13.4% and total revenue growth of 23.4%.

It is a delicate balancing act. On the one hand the government had to act to stave off a looming ratings downgrade. However, the coming election meant it also had to be mindful of popular opinion by ramping up public expenditure on welfare schemes.

Rahul Bajoria, regional economist at Barclays Capital and one of Euromoney County Risk’s expert economists, says: “The initiation of public-private partnerships is a good step but they have a required adjustment period before the impact is really felt on the economy. So it does go one step forward in addressing the long-term structural issues of the economy.”

The deficit reduction target – despite the forthcoming election – shows a commitment by the government to tackle the country’s deteriorating fiscal position and bolster its investment portfolio, according to analysts.

A report by Moody’s recognizes that “sharp spending cuts helped the Indian government reduce its fiscal 2013 deficit to 5.2% of GDP from 5.7% in fiscal 2012 and offset a weaker-than-expected revenue increase of 15.4% that resulted from slumping GDP growth”.

The government’s ability to meet its deficit-reduction target in 2013 is seen as credit positive by Moody’s, especially in light of previous government targets. “The Indian government was able to exceed its deficit-reduction target for fiscal 2013, even as growth decelerated to around 5% for the fiscal year, from 6.2% a year earlier,” said the ratings agency.

“That is a switch from past behaviour, when the government only met or outperformed its budget targets when GDP growth was high.”

The budget comes as Indian economic growth slowed to 4.5% in the fourth quarter of 2012, hitting a three-year low. However, real GDP growth projections for this year point to a turnaround in the Indian economy.

The IMF projects growth of 5.9% in 2013 and 6.4% in 2014, suggesting the economy will rebound in the next fiscal year.

Creating growth

A number of measures that it is hoped will be growth-inducing are outlined in the budget. First, the government’s decision to opt for a more moderate fiscal consolidation programme is likely to be more favourable for economic growth than one that cuts too deeply and rapidly.

“An aggressive fiscal consolidation effort would have been difficult to achieve given that low incomes significantly constrain the government’s revenue base and necessitate social expenditures,” says Moody’s.

Secondly, proposed taxes offer strong incentives for private-sector investment across all industries. “The budget made the right noises about restoring investor confidence, but the follow-up will be important,” reports Capital Economics.

“The finance minister promised to deal with investors’ misgivings about retroactive taxation and controversial anti-avoidance tax rules to uphold the principle of a fair and stable tax policy regime.”

Additionally, the government’s commitment to reduce the budget deficit through moderate fiscal adjustment targets paves the way for monetary easing, which would revive growth, according to Moody’s. At 7%, inflation remains stubbornly high in comparison with other developing economies.

The risks posed by high inflation forced the central bank, the Reserve Bank of India (RBI), to cut interest rates in a bid to boost an economic recovery. Moody’s reports: “The extent of easing would depend on whether the RBI – which has noted that ‘sustained commitment to fiscal consolidation is needed to generate monetary space’ – believes that the government has provided evidence of such a commitment in its budget.”

India will remain rated as investment grade, according to ECR analysts. Several aspects of the budget are credit positive for the country, according to Bajoria at Barclays Capital, and should enable the country to retain its investment grade. “Our consensus is that the budget goes far enough to maintain India’s BBB- credit rating,” he says.

“Most of the rating agencies were expecting a large slippage in this year’s fiscal numbers, given that the fiscal deficit has been tightened to 5.2% this year – better than what was earlier anticipated by the rating agencies. [This] has given the government enough breathing room on the credit outlook and we don’t think a downgrade is on the cards for India.”

Shares of banks in India have been under pressure recently amid continuing doubts about how aggressive the central bank will be in cutting interest rates in the short and medium term.

Shares fell even after the Indian government said late last month that it was still able to pass reform legislation in parliament, which failed to address investor concerns about the prospect of early elections or stalling reforms.

Concerns are rising about the knock-on effect for foreign investor flows, an increasingly important factor for Indian businesses.