Thursday, January 2, 2014

Indian Economy headed for downfall in 2014

2014 is likely to be another difficult year for India as far as economy is concerned. There's no clarity if growth has bottomed out or if the persistent high inflation has peaked.

For Finance Minister P Chidambaram, the immediate challenge, however, will be curtailing India's fiscal deficit to 4.8 per cent of gross domestic product (GDP).

For the first eight months (April-November) of FY14, fiscal deficit, or the difference between the government's expenditures and its revenues, has reached Rs. 5.1 trillion or 94 per cent of the full-year target.

That's much higher than last year, when fiscal deficit for the comparable period stood at around 80 per cent of the target.

Why fiscal deficit is a big challenge?

Ratings agencies like Standard & Poor's have threatened India with a downgrade if the government is unable to control its high fiscal and current account deficits. India has the lowest investment grade rating and a cut to "junk" status would raise its borrowing costs and could trigger panic in financial markets.

Mr Chidambaram has successfully managed to rein in India's record current account deficit (difference between export and import of goods, services and transfers), but fiscal deficit continues to be a big threat.

Why fiscal deficit has got out of control?

Weak revenue collection amid a slowing economy, inability to push asset sales amid the turmoil in financial markets and elevated spending ahead of general elections have led to a larger deficit this year.

As of November 30, tax collection has grown at 7.2 per cent y-o-y (versus the budget target of 19.1 per cent for the full year), while expenditure grew at 17.7 per cent y-o-y against the budgeted target of 16.5 per cent, economists from Nomura estimated.

Besides, fuel subsidy for the current fiscal is likely to be at very large, thanks to sharp decline in the rupee. In fact, for the first eight months, the government has reportedly utilised 83 per cent of its subsidy payout (fuel, food and fertiliser) of Rs. 2.2 trillion.

What can Mr Chidambaram do to control fiscal deficit?

The finance minister can cut back expenditure like last year, when the government oversaw cuts worth over Rs. 1 trillion to control fiscal deficit. This will, however, be tricky ahead of the general elections due by May 2014. The move will also hurt India's already sluggish growth.

Mr Chidambaram can also sweep as much as Rs. 1 trillion in subsidy costs into next year's accounts to ensure he hits fiscal targets are met. This move, however, will saddle the next government with large costs.

The finance minister can also go ahead with share sale in PSU firms to raise the targeted Rs. 55,000 crore through disinvestment. He can get another Rs. 40,000 crore through spectrum auction in February. This will help the government raise nearly Rs. 1 trillion to fund deficit.

Can Mr Chidambaram keep the deficit within the red line?

Surely he can, but the correct question to ask is at what price? India needs to grow at 8 per cent to create enough jobs for its young population, but at less 5 per cent (for the first two quarters), the country is currently growing at the slowest pace in a decade.

That means 2014 may turn out to be another year of lost opportunities for a country that not too long ago was seen as a credible alternative to China.