Monday, March 4, 2013

India growth disappoints, Budget could have done more

India's GDP growth slowed further than expected in the year to December, falling to 4.5% from 5.3% in September.  The good news is that lower than expected inflation in January means there is a bit more room for the Reserve Bank of India to cut interest rates.  The bad news is the 2013 Budget failed to further address India's structural problems.

The disappointing growth rate for the year to December will make it difficult for the Government to meet its forecast growth rate for the 2012/13 (year to March 2013) of 5%.  The weakness was across all broad sectors of the economy.  Net exports remained weak on the back of soft exports, but still high imports fuelled by still high imports of oil and gold.

Inflationary pressures eased somewhat in January with the Wholesale Price Index (WPI) falling to 6.62%, down from 7.18% in December.  The CPI remained elevated at 10.79%, however policymakers continue to focus on the WPI in India.

The Reserve Bank of India (RBI) last cut the policy repo rate by 0.25% in January.  That followed a long 9-month stand-off between the government and the central bank over the need for broader policy changes (particularly lower government spending and reform in the goods market).   The rate reduction was on the back of some moderation in inflationary pressures but was also partly reward for positive moves from the Government late last year to open up the retail and aviation sectors and ease caps on capital inflows.

The lower inflation number in January provides scope for further rate cuts.  However, the RBI has stated that scope for further interest rate reductions remains limited.  I think they will cut rates by another 50 bps.

The RBI's view on its room to move won't have changed with the release of the Government's 2013 Budget last week.  The Budget left deficit projections for the current and next financial year largely unchanged at 5.2% in FY 2012/13 (previously 5.3%) and 4.8% in 2013/14 (unchanged).

But rather than reducing unsustainable subsidy expenditure, the Government increased subsidies from 1.82 trillion rupees in 2012/13 to 2.4 trillion rupees in 2013/14.  That will be funded by a 1-year 10% surcharge on higher income citizens along with higher import duties on some luxury items.  That's not my definition of structural budget reform.

The Government also announced higher spending in education and health and an increase in capital spending.  It's hard to argue about investment in those areas, but he quality of the outputs remains to be seen.  And it would have been preferable for increased expenditure in those areas to be funded by lower spending on subsidies.

In terms of GDP growth, the Government's forecast for FY 2012/13 remains at 5.0% with an increase to between 6.1% and 6.7% expected in FY 2013/14.  My forecasts are 4.8% and 5.8% respectively.

The Government's growth forecasts are still well shy of their stated aspiration of 8.0% growth.  India saw growth rates in excess of that level following the GFC, but with that high growth came sharply higher inflation, indicating that growth of that level was well in excess of potential. 

If the Government wants to achieve sustainable 8% growth, they need to get serious about measures to enhance productivity and improve their budget fundamentals.  In that respect Budget 2013 was a lost opportunity.