Mumbai: The Budget is over and things look satisfactory on the fiscal front. But the greatest danger to the government’s economic growth estimates comes from inflation, which is now not restricted to food and commodities alone, says Michael Spencer, chief economist and head of global markets (Asia) at Deutsche Bank AG. Edited excerpts from an interview:
How do you rate the Budget?
It hit most of the points we were expecting. Certainly, in terms of financial data it was bang in line with our expectations. We welcome the transparency the government has given to the medium-term fiscal consolidation strategy. This was needed particularly when you look at the broader perspective; when there is growing concern around the world about sustainability of government finances. Among industrial countries, India was the one country in Asia, which has a relatively high debt to GDP (gross domestic product) ratio, and the ratio has been going up in the last couple of years.
Where we would have liked to see a little bit more discussion on was around the strategy for reducing fuel subsidies, for example, and food subsidies. There, I gather, it’s more a legislative process.
Graphic: Ahmed Raza Khan/Mint
Do you think the Budget is inflationary?
I don’t think the Budget is inflationary. You are raising taxes and increasing fuel prices. That gives you a temporary increase in prices. But the fact is that the government is scaling back its role as an economic agent.
(But) I think that there are real concerns about inflationary outlook in India. There is tremendous optimism (in India) about the demand side of the equation. And a lot of concern about whether supply can keep pace with demand, whether it be financial services or power generation. Not just in infrastructure, which most investors recognize as a sort of ongoing constraint, but in industry and services. That, to be honest, we do not hear anywhere else in world, certainly nowhere else in Asia. So, I do think there’s a little bit excess optimism that this is just about food prices, commodities…and by the end of the year, inflation will be clearly falling. But it is not clear to me that inflation is going to fall as fast as people expect.
Are you concerned about the government’s expenditure targets being a bit optimistic?
If we have concerns, it’s more on the revenue side. There’s generally a consensus of sorts in India (about growth), which we think is too optimistic. As we look through the last couple of quarters, inflation seems to have imposed more of a drag on consumption than people were expecting, even relative to our own expectation in the fourth quarter of the calendar year (2009). The numbers were a few tenths below our forecasts. On the expenditure side, what disappointed was consumption. In an environment where we think inflation is going to be 8.5% by the middle of the year and (is) probably not falling (as) quickly as people expect, there is going to be a bit more subdued consumption.
So, to the extent that India has suffered a pure supply shock to food for example, that hopefully will come off. But we have a real concern that core inflation is picking up.
Has the government done enough to curb inflation?
I expect the Reserve Bank (of India) will. There might be a couple of reserve requirement increases and we are looking at rates going up 125 basis points this year. There will be more rate hikes in 2011. So initially, real interest rates might be declining, but by the end of the year it’s clear (that) monetary policy will become measurably tighter.