New Delhi: India's pledge to enact the biggest budget-deficit reduction in 19 years may offer the central bank more scope to rein in inflation without choking off lending growth.
Finance Minister Pranab Mukherjee on Friday unveiled plans to cut the deficit to 5.5 per cent of gross domestic product in the year starting April 1 from 6.9 per cent the previous year. Tax increases and Rs400 billion (Dh31.8 billion) of state asset sales will shrink a debt burden equivalent to about 82 per cent of the economy.
Prime Minister Manmohan Singh's government will need to tap less of the nation's savings than anticipated, lessening the impact on private credit growth from higher interest rates. The Reserve Bank of India may start boosting its benchmark rates at or before the next policy gathering in April, according to Goldman Sachs Group.
"By cutting the deficit, the finance minister has made room for monetary tightening without crowding out" lending to private businesses, said K. Ramanathan, who helps manage the equivalent of Rs22 billion at ING Investment Management in Mumbai.
The reduction in the budget deficit will also check borrowing costs from rising in the economy, Montek Singh Ahluwalia, deputy chairman of the Planning Commission, an agency that sets India's growth and investment targets, said in an interview in New Delhi yesterday.
"I would not assume that you'll see that big a rise in the interest-rate structure in the course of the year," Ahluwalia said. "As a percentage of GDP, the deficit is significantly lower than earlier."
Stocks rose after Friday's budget release, with the benchmark Sensitive Index gaining 1.1 per cent in Mumbai, helping pare losses since the start of the year that were spurred in part by global investor concern about sovereign debt quality. Bonds at first rallied, then closed lower on concern a rise in the tax on fuels will boost energy costs and worsen inflation.
Fitch Ratings analyst Andrew Colquhoun said "we are marginally less encouraged to go for a downgrade" in India's sovereign debt rating after the budget proposal. Standard & Poor's said in a statement that it may raise its rating outlook to stable should finances improve, echoing similar remarks by Moody's Investors Services before the release.
Fiscal consolidation
Moody's ranks India's rupee-denominated debt at Ba2, two levels below investment grade, while Fitch and S&P have a BBB- rating, the lowest investment grade. That puts India below its Bric counterparts — China, Russia and Brazil.
Central banks are urging governments to curb deficits after the global recession ended and after Greece's debt downgrade hit the euro. US Federal Reserve chairman Ben Bernanke last week said high deficits may cause "crowding out" of investment and Bank of Japan governor Masaaki Shirakawa last week called for a "path for fiscal consolidation".
In India, fiscal stimulus measures saw the deficit climb from 2.7 per cent of GDP two years ago. The fin-ance ministry yesterday said public debt sales will rise by 1.3 per cent, less than the 2 per cent median forecast in a Bloomberg News survey, to Rs4.57 trillion in the next fiscal year.
Central bank governor Duvvuri Subbarao last month warned that fiscal stimulus given since 2008 — worth more than 4 per cent of GDP — must be withdrawn to ensure companies have access to funds.
"With fiscal policy in train, the focus will now shift to monetary policy to remove its massively accommodative stance," Tushar Poddar, chief economist at Mumbai-based Goldman Sachs India Securities, said in a report. He said the RBI may raise interest rates by 3 per centage points this year to slow "rising domestic demand and inflationary pressures".
Friday's budget numbers are counting on a smooth series of asset sales, wireless licence auctions and increase in tax revenue as the economy expands, JPMorgan Chase analysts said in a note. Should the deficit objective be reached, there will be "space for a strong pick-up in investment and credit growth".
"If a few things go wrong, the budget will look shaky," Mumbai-based JPMorgan analysts Jahangir Aziz and Gunjan Gulati said in the note. "The global recovery can turn up nasty surprises and create enough anxiety to keep domestic financial markets volatile."
Policymakers are working to unwind Rs7.5 trillion of tax and interest rate cuts to curb consumer-price inflation that's the highest in the Asia-Pacific region, according to data compiled by Bloomberg.
