There's nothing in India's budget to cause a political crisis or spook investors
March 5, 2006
Indian finance minister P Chidambaram deserves applause for using the opportunity provided by rapid economic growth to put rickety government finances on a more stable footing.
India's federal government aims to cap its budget deficit at 1.487 trillion rupees (R207 billion) in the 2007 fiscal year starting April 1, Chidambaram announced in parliament on Thursday while presenting the annual budget.
As a ratio of gross domestic product (GDP), the shortfall will ease to 3.8 percent, from 4.1 percent of GDP in the current year ending March 31.
The pace of reduction is in line with the Fiscal Responsibility and Budget Management Law of 2004. With the public debt burden equal to 90 percent of GDP, fiscal rigidity is the biggest challenge to India's creditworthiness.
Even with a banking system far healthier than China's, India is rated four levels below its Asian rival by Standard & Poor's, places India's foreign currency long-term debt at BB+. Closing the gap will enable Indian companies to raise money more cheaply overseas.
A better credit profile may even give the Indian government the much-needed confidence to borrow internationally, rather than continuing to repress the local banking system by scooping out a large part of household savings for state spending.
Unless economic growth collapses next year, after this year's estimated 8.1 percent expansion, Chidambaram should meet his target comfortably.
Projections for tax collection are somewhat aggressive, though not overly so. Rough calculations show that the finance minister is anticipating nominal GDP growth of about 11 percent. Assuming inflation, as expressed by the GDP deflator, at this year's level of 4.5 percent, real economic growth need be no more than 6.5 percent next year for Chidambaram to meet his goal.
At this juncture, one can foresee three risks that could sharply drag down India's economic growth rate and jeopardise the deficit-reduction target. First, a fresh spike in oil prices could push up raw material costs for companies, leading to lower profits.
Second, if inflation begins to pick up, or if the rupee slumps against the US dollar, the central bank may raise interest rates again, arresting the growth in corporate investments.
Third, if the seasonal monsoon rains are insufficient in the June to September period, farm incomes might come under stress. Three out of five Indians depend on farming and related occupations for their livelihoods.
Chidambaram has made an attempt to shield the economy from all three risks. He has promised to pump money into irrigation projects. Banks are being asked to step up credit to farmers.
The budget is also supposed to reduce the inflation and interest rate risks facing the economy. The peak import tariff has been cut, which should make imported goods cheaper. Chidambaram has also pared government levies on cooking gas, processed food, writing paper, shoes and cars.
With the government taking it upon itself to control inflation, the central bank will need a very good reason to raise the overnight interest rate from 5.5 percent when it announces its quarterly monetary policy on April 18. If anything, the central bank will have to inject more cash into the banking system to satisfy both the government and the private sector's appetite for credit.
Chidambaram is trying to narrow the fiscal gap without raising income tax, or cutting back on government expenditure on assets (roads and power stations), or education and health.
Fitch Ratings is concerned that the budget didn't make any effort to curb state subsidies, leaving fiscal consolidation almost entirely dependent on economic buoyancy. "Any sudden downturn in growth could manifest itself in a sharp rise in public debt, as occurred between 1999 and 2003," says Paul Rawkins, a London Fitch analyst.
Had Chidambaram been the finance minister in a government that wasn't being pulled to the left by the Marxists, he might have aggressively sold state assets and rationalised subsidies on food, fertilisers and fuels.
His political compulsions don't allow him that manoeuvrability. It's, therefore, perfectly sensible of him not to announce bolder targets for deficit reduction that would never be met.
Chidambaram has done well to choose pragmatism over ambition. There's nothing in the budget that could cause a political crisis, stall economic growth or spook investors.
Unless India is terribly unlucky with rains this year, economic growth should remain strong. That will lift all boats, including the rather leaky raft of government finances. - Bloomberg
|
|
