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India
The overrun in the fiscal deficit is a reminder of the extent to which the country’s structural weaknesses remain acute. The
rating agencies are starting to worry about the lack of structural improvement in Indian public finances. And yet, the
government will not take any major reforms before the next elections, in 2014. There is no cause for optimism in the short
to medium term. While the Indian economy has rebounded, pulled along by household consumption, investment remains
depressed and the growth outlook could be revised downwards if the Reserve Bank of India does not substantially cut its
interest rates. The central bank’s room for manoeuvre, however, has diminished in recent weeks.
Suffering from structural weaknesses
Household consumption continues to hold up but
investment remains depressed
The recovery in activity was confirmed in January. Growth in industrial
production continued to increase (+6.8% yoy), spurred by vigorous household
consumption. The main source of concern remains the contraction in the
production of capital goods, reflecting the sharp decline in business investment
which is struggling to pick up again. Furthermore, there are no signs pointing to a
trend break. Against this backdrop, the growth outlook could be revised
downwards for the 2012-2013 fiscal year, especially given that leeway for a cut
in interest rates has diminished.
Fiscal deficit revised upwards from 4.6% to 5.9%
The central government’s deficit for the 2011-2012 fiscal year has been revised
upwards by 1.3 percentage point to 5.9% of GDP) and the general government
deficit could reach 8.5% of GDP. Out of the BRICs, and even among Asian
emerging countries, India is one of the countries with the most fragile public
finances. The general government’s fiscal deficit has averaged 7.5% of GDP
over the past ten years. Ultimately, the improvement over the period 2003-2007
was merely the result of vigorous growth, not from the implementation of
structural reforms by the government with a view to permanently reducing its
deficit.
An analysis of the Indian government’s budget highlights on the one hand a high
sensitivity of fiscal revenues to growth in industry and, on the other hand, rigid
government expenditure.
In the 2011-2012 fiscal year, the fiscal overrun resulted from an increase in the
cost of subsidies, up 55% from their budgeted levels. The government’s
subsidies (on the prices of food products, fertilizers and fuel oil) reached 2.4% of
GDP compared with the 1.3% initially forecast due to the increase in commodity
prices.
Moreover, interest payments on the debt are weighing on the government’s
flexibility in terms of expenditure.
The central government’s tax revenues, for their part, fell circa 3% compared
with budgeted deficit. Given the structure of the tax system, the government’s
revenues are highly dependent on manufacturing activity on the one hand and,
on the other, taxes on corporate earnings, which represent 35% and 22%
respectively of the government’s revenues. The government’s budget is
therefore highly dependent on commodity prices, the exchange rate and
industrial activity.
As long as the government fails to implement structural reforms aimed at
broadening the tax base and reducing the weight of subsidies, there will de facto
be no lasting fall in the fiscal deficit and it will continue to weigh on growth – in
addition to possibly weighing on India’s sovereign credit rating.
The government’s fiscal leeway to stimulate growth and carry out the necessary
investments to reduce strains on production capacity is extremely limited and is
eroding the country’s potential growth.
Yet no reform will be introduced before the next elections in 2014. As a result,
and in light of the domestic and international economic environment, the
government’s budget forecasts for the 2012-2013 fiscal year seem too optimistic
(deficit forecast at 5.1% of GDP). In particular, the government plans to keep the
cost of the subsidies below a threshold of 2% of GDP, which appears extremely
ambitious given the trend in oil prices.
Monetary policy increasingly constrained
There are a number of monetary policy constraints: the increase in inflation
figures for February (+7% yoy versus +6.6% in January), the fiscal slippage,
rising oil prices and pressure on the rupee. The monetary authorities’ room for
manoeuvre to cut their interest rates is diminishing at a time when the need to
stimulate business investment is becoming increasingly pressing. Currently, the
only instrument that remains available to the central bank to try to ease liquidity
strains is a reduction in the cash reserve ratio, which was lowered to 4.75% at
the latest monetary policy meeting in March (i.e. a 75 bp cut). Nevertheless,
strains remain acute and the lack of liquidity continues to grow. Under these
conditions, the banks’ situation is becoming more worrying and the quality of
their portfolios is expected to deteriorate. The hypothesis of a cut in interest rates
is still favoured, but given the economic environment, it could be too modest to
provide a sufficient boost to business investment.
The rupee still under pressure
The latest balance of payments statistics reveal a marked deterioration at the
end of the year. India’s current-account deficit deepened further in the fourth
quarter of 2011 (USD -19 billion) and capital inflows fell (from 17 billion in Q3-11
to less than 8 billion in Q4), in particular loans and portfolio investment, while
foreign direct investment recorded a slight increase. The balance of payments
deficit reached nearly USD 12 billion in the fourth quarter, a level not seen since
Q4-2008.
Investors remain particularly distrustful with regard to India in light of its structural
weaknesses and downside risks for growth. Whereas the rebound in growth
recorded at the start of the year paved the way for a recovery in confidence and
a strengthening of the rupee, the fiscal slippage announced in recent weeks
combined with the defeat for the governing party at the state elections have
pushed CDS higher and led to a renewed depreciation of the currency. Volatility
remains high and risks of stronger depreciation can not be excluded. Yet
currency depreciation weighs on inflation, the cost of the subsidies and de facto
on public finances and growth.
State elections for the upper house: defeat for the
governing party
The state elections to renew one-third of the upper house provided a perfect
illustration of the social and political discontent among the population. The ruling
party failed to assert itself in the upper house, the government paying the price
for its inability to combat corruption, improve governance and contain inflationary
pressures. In the largest of the states that voted, Uttar Pradesh, Sonia Gandhi’s
party suffered a massive defeat by winning only 28 seats out of 403. The main
opposition party was also rejected by voters, losing 126 seats since the last
elections. The regional parties were the big winners in these elections, above all
the Samajwadi Party (which won 224 seats, i.e. 127 more than in the 2007
elections).
Although the results of these elections do not shed any light on the likely result of
the 2014 general elections, they show that the two national parties will have to
count on support from the regional parties to obtain a majority in the upper
house.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India
The overrun in the fiscal deficit is a reminder of the extent to which the country’s structural weaknesses remain acute. The
rating agencies are starting to worry about the lack of structural improvement in Indian public finances. And yet, the
government will not take any major reforms before the next elections, in 2014. There is no cause for optimism in the short
to medium term. While the Indian economy has rebounded, pulled along by household consumption, investment remains
depressed and the growth outlook could be revised downwards if the Reserve Bank of India does not substantially cut its
interest rates. The central bank’s room for manoeuvre, however, has diminished in recent weeks.
Suffering from structural weaknesses
Household consumption continues to hold up but
investment remains depressed
The recovery in activity was confirmed in January. Growth in industrial
production continued to increase (+6.8% yoy), spurred by vigorous household
consumption. The main source of concern remains the contraction in the
production of capital goods, reflecting the sharp decline in business investment
which is struggling to pick up again. Furthermore, there are no signs pointing to a
trend break. Against this backdrop, the growth outlook could be revised
downwards for the 2012-2013 fiscal year, especially given that leeway for a cut
in interest rates has diminished.
Fiscal deficit revised upwards from 4.6% to 5.9%
The central government’s deficit for the 2011-2012 fiscal year has been revised
upwards by 1.3 percentage point to 5.9% of GDP) and the general government
deficit could reach 8.5% of GDP. Out of the BRICs, and even among Asian
emerging countries, India is one of the countries with the most fragile public
finances. The general government’s fiscal deficit has averaged 7.5% of GDP
over the past ten years. Ultimately, the improvement over the period 2003-2007
was merely the result of vigorous growth, not from the implementation of
structural reforms by the government with a view to permanently reducing its
deficit.
An analysis of the Indian government’s budget highlights on the one hand a high
sensitivity of fiscal revenues to growth in industry and, on the other hand, rigid
government expenditure.
In the 2011-2012 fiscal year, the fiscal overrun resulted from an increase in the
cost of subsidies, up 55% from their budgeted levels. The government’s
subsidies (on the prices of food products, fertilizers and fuel oil) reached 2.4% of
GDP compared with the 1.3% initially forecast due to the increase in commodity
prices.
Moreover, interest payments on the debt are weighing on the government’s
flexibility in terms of expenditure.
The central government’s tax revenues, for their part, fell circa 3% compared
with budgeted deficit. Given the structure of the tax system, the government’s
revenues are highly dependent on manufacturing activity on the one hand and,
on the other, taxes on corporate earnings, which represent 35% and 22%
respectively of the government’s revenues. The government’s budget is
therefore highly dependent on commodity prices, the exchange rate and
industrial activity.
As long as the government fails to implement structural reforms aimed at
broadening the tax base and reducing the weight of subsidies, there will de facto
be no lasting fall in the fiscal deficit and it will continue to weigh on growth – in
addition to possibly weighing on India’s sovereign credit rating.
The government’s fiscal leeway to stimulate growth and carry out the necessary
investments to reduce strains on production capacity is extremely limited and is
eroding the country’s potential growth.
Yet no reform will be introduced before the next elections in 2014. As a result,
and in light of the domestic and international economic environment, the
government’s budget forecasts for the 2012-2013 fiscal year seem too optimistic
(deficit forecast at 5.1% of GDP). In particular, the government plans to keep the
cost of the subsidies below a threshold of 2% of GDP, which appears extremely
ambitious given the trend in oil prices.
Monetary policy increasingly constrained
There are a number of monetary policy constraints: the increase in inflation
figures for February (+7% yoy versus +6.6% in January), the fiscal slippage,
rising oil prices and pressure on the rupee. The monetary authorities’ room for
manoeuvre to cut their interest rates is diminishing at a time when the need to
stimulate business investment is becoming increasingly pressing. Currently, the
only instrument that remains available to the central bank to try to ease liquidity
strains is a reduction in the cash reserve ratio, which was lowered to 4.75% at
the latest monetary policy meeting in March (i.e. a 75 bp cut). Nevertheless,
strains remain acute and the lack of liquidity continues to grow. Under these
conditions, the banks’ situation is becoming more worrying and the quality of
their portfolios is expected to deteriorate. The hypothesis of a cut in interest rates
is still favoured, but given the economic environment, it could be too modest to
provide a sufficient boost to business investment.
The rupee still under pressure
The latest balance of payments statistics reveal a marked deterioration at the
end of the year. India’s current-account deficit deepened further in the fourth
quarter of 2011 (USD -19 billion) and capital inflows fell (from 17 billion in Q3-11
to less than 8 billion in Q4), in particular loans and portfolio investment, while
foreign direct investment recorded a slight increase. The balance of payments
deficit reached nearly USD 12 billion in the fourth quarter, a level not seen since
Q4-2008.
Investors remain particularly distrustful with regard to India in light of its structural
weaknesses and downside risks for growth. Whereas the rebound in growth
recorded at the start of the year paved the way for a recovery in confidence and
a strengthening of the rupee, the fiscal slippage announced in recent weeks
combined with the defeat for the governing party at the state elections have
pushed CDS higher and led to a renewed depreciation of the currency. Volatility
remains high and risks of stronger depreciation can not be excluded. Yet
currency depreciation weighs on inflation, the cost of the subsidies and de facto
on public finances and growth.
State elections for the upper house: defeat for the
governing party
The state elections to renew one-third of the upper house provided a perfect
illustration of the social and political discontent among the population. The ruling
party failed to assert itself in the upper house, the government paying the price
for its inability to combat corruption, improve governance and contain inflationary
pressures. In the largest of the states that voted, Uttar Pradesh, Sonia Gandhi’s
party suffered a massive defeat by winning only 28 seats out of 403. The main
opposition party was also rejected by voters, losing 126 seats since the last
elections. The regional parties were the big winners in these elections, above all
the Samajwadi Party (which won 224 seats, i.e. 127 more than in the 2007
elections).
Although the results of these elections do not shed any light on the likely result of
the 2014 general elections, they show that the two national parties will have to
count on support from the regional parties to obtain a majority in the upper
house.
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