A crisis can trigger change. In India, a political one got created last week to accomplish this. In a series of economic blasts, the government adjusted fuel prices; eased foreign direct investment rules, notably in multi-brand retail; cut taxes on domestic firms’ foreign borrowings; launched a scheme to attract retail investors into equity markets; suggested creating a single-window, final clearance body for large projects; presented a debt recast plan for the power sector; and admitted a fiscal deficit overshoot to about 5.3% of GDP, explaining subsidies’ restriction to 2% of GDP might be difficult, while a detailed fiscal consolidation plan by an expert panel is expected to recommend monetization of disposable land to stem the fiscal bleeding. The list isn’t exhaustive and expectations have been created for more to follow.
All this has successfully restored investor confidence, market sentiment and the overall mood. A heaven-sent deluge of overseas liquidity also joined in the market rally since. The question however is how soon can this tide lift the sinking Indian boat?
Start with the fiscal deficit, at the eye of the storm created by raters. Diesel price increases and the LPG subsidy cap will result in fiscal savings of 10-15 bps as per most estimates. The rest is up in the air for now. The structural deficit, including the mix of capital and current public spending, remains untouched. The booster injections set up the stage for raising non-tax revenues though: the new, determined team at the helm of affairs is optimistic on disinvestment, expecting Rs15000 crore from part sales in four pricey public firms as market sentiment changes. That is half the disinvestment target, which itself is expected to be raised a bit.
The attempts to revive foreign capital inflows will help finance the current account deficit, although mostly from ‘bad’ flows, i.e. volatile debt, in the near term. The rupee gets supported on a short-term basis too; its fundamentals remain unchanged however. A stronger currency in turn helps contain oil import prices, a key source of vulnerability.
How about growth? As the consumption cycle consolidates after growing 7% annually in past three years, the investment cycle has to resume, replacing this decline and driving growth ahead. The suggested creation of a National Investment Board could provide a useful stimulus if this ensures that projects worth Rs1000 crore plus actually take off; that would impact ahead with multiplier effects. But the role of saving rates is critical in retaining the savings-investment equilibrium, for which there is little in this response set. Inflation, an important factor underlying the decline in household savings and which continues at 10% at the retail level, will remain unmoved in the absence of significant, short-term demand management from the fiscal side.
Thus there is little to change the fundamental macro imbalances in the short run. Rating agency Standard & Poor’s, which cut India’s GDP growth forecast to 5.5% on Monday, confirmed as much, adding that the announced actions, if actualized will impact over the medium to long run. Nonetheless, the responses provide critical external sector support for macroeconomic stabilization and introduce hope that the bleeding is at last beginning to get arrested.
Renu Kohli is a New Delhi-based macroeconomist; she is a former staff member of the International Monetary Fund and the Reserve Bank of India.
