Budget fails to better growth prospects: Moody's

Sherman Chan, Economist, Moody's Economy.com has expressed disappointment over Indian government's failure to take strong measures to shield economy from fierce headwinds.

In a report, Chan has said the government's failure to take new initiatives to stimulate the economy has seen the benchmark stock index declining for three straight days following the budget announcement.

The government’s advance GDP estimates, which point to an annual growth of 7.1% for the year ending March 31, seem too optimistic. A closer look at the breakdown reveals the reason. Although the authorities are right in projecting  a  moderation in manufacturing  (from  8.2%  to  4.1%) and construction (from 10.1% to 6.5%), the pace of slowdown should be sharper given the slump in exports and a cooling real estate sector.

In line with the rest of the region, a steep deceleration in growth during the  December quarter is expected. Moody’s Economy.com forecasts a growth rate of 6.8% for fiscal 2008-2009 and 6.1% for  the next year. The government needs to significantly raise spending to sustain growth at over 7%. However, the fiscal deficit once again puts a curb to that path.

The fiscal shortfall for the current year is officially projected to hit an 18-year high and correspond to 6% of GDP against a target of 2.5%. The fiscal deficit for next year is unlikely to improve much, with an estimate at 5.5% of GDP compared with a target of 3%. 

Financing is a major hurdle to introducing stimulus measures, given  the already heavy public debt. The subsidies program India has in place may now have been proven problematic, as it was one of the largest expense items.

The Indian authorities are reluctant to introduce further tax cuts, which is understandable, as they would cause a deterioration in the fiscal position. In fact, the actual fiscal deficits may end up much bigger than projected, as the decline in tax revenue could be more severe than expected, which is likely given the optimistic growth forecast adopted by the government.

The fiscal position is perhaps India's Achilles heel from foreign investors’ perspective. India's large market is also one of the fastest growing ones, but the massive public debt has weighed on investor confidence. The government will be in urgent need to clean up its balance sheet after the global storm. For now, the weak fiscal position has put pressure on the central bank to use monetary policy in reviving growth.

The interim budget may be reviewed once the new administration is elected in  May. However, until then the focus is on the Reserve Bank of India to loosen monetary policy and stimulate economic activity. Moody’s Economy.com expects an interest rate cut next week, following the release of some downbeat GDP data.