Thursday, 19 September 2013

Indian government avoiding tough financial fixes as elections approach

Concerns are rising over India’s battered currency as it experiences a 20% loss in value this year. Other worrying reports suggest India could dip to only 5.3% GDP growth at the end of the financial year March 2014. Regrettably the many underlying structural weaknesses are unlikely to be fixed with tougher policies.

There are plans to set the economy on track, but there are legitimate concerns they will not be broad or robust enough to convince foreign observes to stay interested in the stumbling Indian financial system.

India’s labyrinthine regulations and stifling bureaucracies often frighten investors away, but rather than address these structural issues directly and avoid obstacles in the future, the government appears to be more concerned about the plight of the rupee and winning votes.

After emerging from a decade of healthy growth rates averaging 7.7%, 2013 will be the first year India may not hit an IMF target of 5.6%. Government economists blame unsustainable spending on fuel subsidies, poor infrastructure, and distressing fiscal and current account deficits for their currency woes. On top of this, Indians could be exacerbating the situation by moving to gold to hedge against a falling rupee.

The world’s second-largest country by population watched its currency slip to an all-time low of 68.85 against the US dollar at the end of August. The slide stems from India’s expensive and uncompetitive manufacturing sector which keeps export levels low and imports high, resulting in a current account deficit of 6.7% of GDP at the end of 2012.

A weaker currency should help India to boost exports, or at least it would in healthier economies. Unfortunately for New Delhi, major legislative and structural obstacles will stymie many benefits of a weaker rupee.

The new governor of the Reserve Bank of India Raghuram Rajan – who became the bank’s head September 4 - is determined to ensure any future actions by India’s central bank will be transparent and structured carefully to stabilise asset prices in financial markets.

In a recent move, the RBI sold US dollars from its reserves to oil importers to prevent further declines. The intervention balanced the rupee and probably held off a dangerous currency crisis but at the cost of dipping into India’s foreign exchange reserves.

Mr Rajan is showing good signs he can steer the Indian economy through these tough times, with India projected to end the fiscal year next March with 4.5 to 5% growth. Though it is something of a veneer, as the steps will be short-term fixes avoiding the structural weaknesses in the economy which are largely to blame for the present predicament.

The government’s foreign reserves are stronger today than in 1991; with about a seven month buffer for imports should the situation take a turn for the worse. If India can reach 5% growth this financial year, it might avoid a major crisis similar to the doldrums of 1991 where the rupee fell sharply and foreign exchange levels hovered near critical levels.

With general elections approaching in May 2014, India’s fiscal reality is worrying the government.
Investors have noticed the historical pattern during Indian elections of temporary rather than structural changes and few believe the government is willing to do what is necessary if it threatens precious votes. International investors need to know any changes made in the run up to the election will not disappear after it is over.

One of these changes will address India’s inefficient and corrupt food distribution system. The country has over 800 million rural and urban poor people and a US$22 billion expansion of the inefficient program should help feed hungry Indians at heavily subsidised prices.

India’s Food Security Bill has been on the conveyor belt since 2009 and should clean up some of the murky processes, but it is being criticised as a populist policy. Large-scale spending on food programs will certainly swing votes, but the government’s coffers will suffer and may possibly intensify the economic situation.

While the central bank is making strong announcements of rigidity in future reforms, the Indian government is unlikely to ease the rules on foreign direct investment in multi-brand retail for example. After all, a recent decision to relax those rules caused widespread protests around the country, despite their necessity.

If India can make its rigid labour laws more flexible and remove the onerous red tape it might encourage more foreign companies to invest and could bring the country’s manufacturing sector back into competitiveness.

The chances of India collapsing into a quagmire similar to the 1991 crisis remains low, especially while the country’s foreign debt levels are much lower than 20 years ago. But if New Delhi cannot implement the necessary raft of tough financial and legislative changes, the various economic troubles could fester for many more business cycles to come.

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