Thursday, March 1, 2012

India: monetary vs. fiscal policy

December 2011 India GDP came in at an annual 6.1%, lower than market expectations and down on the 6.9% recorded in the September quarter. The slowdown is in line with recent soft industrial production data with the weakness centred in the manufacturing and mining sectors.

The slowdown in India is consistent with the recent slowing in growth across the other key emerging markets which is, in turn, partly due to the broader global growth slowdown over 2011. In most emerging markets however, that has been accompanied by a waning in inflation pressures and, to varying degrees, an easing in monetary conditions.

The India story is somewhat different. While inflation has eased recently in India, it remains at elevated levels. Wholesale price inflation currently stands at 6.55%, down from 9% over most of 2011. It remains the case that of the emerging economies, higher commodity price inflation has had the greatest spill-over into more generalised inflation in India.

India is also unusual for emerging markets in that it runs a budget deficit. Importantly, it is failing to meet deficit reduction targets. The deficit target for the current fiscal year (ending March 2012) is 4.6%, but it is expected to come in at over 5%. The deficit target for 2014 is 3.5% of GDP.

So, despite the lower than expected growth, the scope for monetary policy to ease is constrained by still (relatively) high inflation and loose fiscal policy. The Reserve Bank of India next considers monetary settings on March 15. It is possible they will further ease the bank reserve ratio (following an initial reduction in January), but will wait to see the outcome of the federal budget on March 16 before considering any move on interest rates.