Tail risks to the economy ease

Govt moves unlikely to cut fiscal deficit & high rates to delay investment revival

After the dust has settled around the spate of “reforms” unleashed by the government late last week, analysts and economists are describing these measures as “ad hoc” and “not substantial enough”. This also explains the central bank’s stance today, which held on to rates but cut cash reserve ratio by 25 basis points to 4.50 per cent. Clearly, the central bank has held on to rates till the growth-inflation balance is restored.

Rapidly slowing growth may have pushed the government into action, but these measures are not sufficient. The market is terming the fuel price hike ad hoc because the need of the hour is to eliminate fertiliser, food, fuel and power subsidies. Sanjeev Prasad of Kotak Institutional Equities does not see the recent price increase in diesel and related announcements on petrol and LPG as substantial reforms. He says: “The government continues to control retail prices and has raised prices modestly after 15 months.”

Though the government has liberalised foreign investment in sectors like retail, aviation and broadcast services, which would eventually result in long-term capital flows into these sectors, there is little that changes in the near-term. As a result, the downgrades continued on Monday, with Standard Chartered Bank’s economists Anubhuti Sahay and Samiran Chakraborty cutting down their GDP growth estimates to 5.4 per cent from 6.2 per cent for FY13. They believe that while these measures will have a positive medium-term impact and will change the perception of policy paralysis in India, they may not have an immediate effect on growth. So far, no move has been made to fast-track investment approvals, which indicates that risks to economic growth are not yet over. For proof one needs to look at the industrial activity over the last three quarters, which has grown by an anemic 0.8 per cent.

Though the financial markets welcomed the moves, the real impact of these measures is minimal. The math shows that the cut in diesel subsidies only adds up to 0.2 per cent of GDP, while the plan to disinvest the government’s stake in four public sector entities is merely 30 per cent of the target set in the Union Budget. Mole Hau of BNP Paribas says: “The aggregate impact of these measures however is relatively limited. The budget deficit is still on course for six per cent of GDP this year. Equally, FDI inflows may take time to materialise let alone effect a pronounced impact on the growth-inflation trade-off.”

But there’s some good news in all of this. While the real impact of this will take some time to materialise, the message that India has sent out to the world is that it’s still “open for business” and this indicates that portfolio flows will lead the stickier foreign direct investments. These flows would also support the rupee as the worst of the tail risks for India seem to be over