Wednesday, June 20, 2012

Why India's $10 bn to Euro zone is big deal

India has graciously committed $10 billion to the International Monetary Fund or IMF to stabilize Europe. China said it will contribute $43 billion. Russia and Brazil have also agreed to contribute $10 billion each. While there is no specific plan announced to disburse the amount, the contribution is significant when one looks at the overall government finances and the current market situation. Since the Euro zone is working on a bailout, it is possible that India may have to payout sooner than later. (Read: India to contribute $10bn to stabilise Euro zone, says Manmohan Singh)

Here is the context for the $10 billion or (Rs 55,000 crore) that India has committed:

The Indian government spends more money than it generates. India’s fiscal deficit is expected to be at 5.1 per cent of gross domestic product or GDP, according to budget estimates for 2012-13. This is approximately $90 billion. Many pundits expect this to surge to 6 per cent or over $100 billion if the government does not cut expenditure.

The Reserve Bank of India did not cut repo rates or benchmark interest rates that we pay for borrowing. This is because it wants the government to reduce subsidies and thereby focus on consolidating the fiscal deficit. While the growth slows, RBI needs maintain low interest rates to stimulate the economy and ease the burden on borrowing for businesses. However, due to the spiraling fiscal deficit, RBI is not able to do so.

The quantum of total subsidies is expected to be $34.5 billion, according to budget estimates in 2012-13.

The Indian rupee breached the Rs 56-mark today. Unlike China and Russia, India has a current account deficit. This means the country imports more goods and services than exports. India’s trade deficit in April 2012 came in at $13.48 billion on Friday, according to data from the Ministry of Trade and Commerce. A falling currency makes thing even more difficult for importers.

Oil imports, which account for the single largest chunk of India’s import bill, increased 7 per cent in April 2012 to $13.9 billion from the corresponding period last fiscal, while non-oil imports were $24.03 billion.