India policy making delays cast shadow on markets

Policymakers in India are in a dilemma, struggling to fathom how best to tackle an economy growing at its weakest annual pace in a decade and a current account deficit which poses a big stumbling block to lowering interest rates. The imbroglio is set to cast a long shadow on the stock, foreign exchange and bond markets.

For much of the past nine years the ruling coalition government, jolted by a spate of political corruption and crony capitalism scandals, remained paralysed in decision-making. The inaction, especially in approvals for large investment projects, has dealt a body blow to the once high-flying economy, which at nearly $2 trillion is Asia’s third largest.

When the policy adrift raised the heckles of global agencies such as Standard & Poor’s, who threatened a possible downgrade of India’s sovereign rating, New Delhi woke up last September and kicked off a series of initiatives to revive foreign investment and tidy up wobbly government finances. The measures, however welcome, failed to be sustained across other sectors of the economy.

High borrowing costs are a huge barrier to consumer spending, corporate investment and sales. With the economy slowing – to 4.8 per cent in the March quarter, and 5 per cent in 2012-13, compared with more than 9 per cent until 2-3 years ago – many companies are saddled with unviable projects and a massive debt burden.

While the political leadership, top bureaucrats and businesses have been persistently lobbying for rate cuts, the Reserve Bank of India (RBI), the world’s most hawkish central bank, is playing hard ball.

“Growth is significantly moderated, inflation is somewhat off its peak but there are several upside risk factors, the balance of payments is under stress and investments have to pick up,” Governor D. Subbarao said in a speech on Thursday, pouring cold water on widespread expectations for a reduction in interest rates on June 17 when the RBI reviews policy.

The comment dented shares, the rupee and bond markets – which had all been betting on a 25 basis points rate cut in June – and the near-term outlook remains subdued.

The top-30 Sensex slumped 2.25 per cent on Friday, its biggest one-day slide in more than two months, to 19,760.30. The wider 50-stock Nifty index shed 2.6 per cent to 5,985.95.

The rupee tumbled to as much as 56.76 to the US dollar, its weakest in

11 months, before closing at 56.50, down 4.8 per cent in May.

“The sharp exchange rate depreciation and the possibility of another large trade deficit reading in May could weigh on Governor Subbarao’s mind and we now believe that it may be enough to drive him to take a brief pause in the policy easing cycle in June,” HDFC Bank analysts led by Chief Economist Abheek Barua wrote in a note.

“Weak growth prospects as well as falling inflation could however continue to create the macro conditions for further policy easing and we expect the RBI to resume its policy easing in July with a 25 bps repo rate cut. This could be followed by another 25‐50 basis points of repo rate cuts for the remainder of 2013.”

India’s economic expansion in January-March was below countries from China to Indonesia and the Philippines but better than advanced economies. After the GDP data was released on Friday, Finance Minister P. Chidambaram said he was confident of 6 per cent or more growth in 2013-14, a target that could be wishful unless government decision-making improves.

“High-frequency indicators suggest that the sequential growth momentum could ease during the April-June quarter as the reform momentum has slowed and global economic conditions have softened. Further progress on structural reforms, which we may not see before the monsoon parliamentary session, will help gradually improve the growth prospects for industry and services,” HSBC economists Leif Eskesen and Prithviraj Srinivas said in a report.

It said the recovery in growth will prove protracted and could materialize slower than initially thought in light of the deceleration in reform announcements and implementation and the lingering global headwinds.

“In turn, this suggests that the risks surrounding our 6.0 per cent GDP growth forecast for 2013-14 are tilted to the downside,” HSBC said.

Output of capital goods, an indicator of spending on factories and machinery, fell for nine of the 12 months through March. Foreign direct investment dropped about 21 per cent to $36.9 billion in

2012-13 from the year before, according to government data.

Belying expectations for an improvement, private consumption fell in the March quarter to 3.8 per cent from 4.2 per cent a quarter ago while gross fixed capital formation slowed to 3.4 per cent from 4.5 per cent. The current-account gap was $32.6 billion in the quarter ended Dec. 31, on gold and oil imports and subdued exports.

On the other hand, the budget gap in 2012-13 was 4.9 per cent of GDP, Chidambaram said, shrinking sharply from 5.2 per cent estimated in February after the government tightened spending drastically to ward off a ratings downgrade.

Undoubtedly the buck stops with New Delhi’s mandarins, and the government needs to lead the way to regain lost ground.

“Rather than worry about what the RBI will do, the government must act to step up investment, which is the only way to reinvigorate the economy,” the influential Economic Times wrote in an editorial on Saturday, titled: Growth calls for proactive policy — GDP numbers challenge the government.

“Its Cabinet Committee on Investment must make delayed clearances history, the enterprises it owns must spend their huge reserves, to create infrastructure. Even more important is getting the policy right. State monopoly in coal is responsible for fuel shortage that has brought down power generation and converted the lines laid under rural electrification into dead capital.”

­ The writer is a journalist based in India