India Economic: Monthly Economic Report February 2008

India Economic: Monthly Economic Report February 2008

Summary

1) The Budget: populism ahead of elections? On 29 February the Finance Minister P Chidambaram presented his 5th Union budget to Parliament. It was another ‘good times’ budget with a strong rural flavour, based on confidence in a continuing high growth story that is largely immune to an uncertain global economic outlook, and making no major adjustments to productive sectors.Emphasis on social sectors likes health, education and especially agriculture through new debt relief measures for farmers has led some commentators to think that an election is imminent. A day earlier he had tabled the Economic Survey 2007-08 in the Parliament that suggested policy recommendation which are necessary for sustaining the growth process. The Railway Budget, which again was populist, was presented on the 26 February.

2) Indian growth story shows signs of slowdown. Strong indications of a slowdown in 2007-8 emerged from the government’s advance estimates that put gross domestic product (GDP) growth at 8.7 per cent. The estimate put out by the Central Statistical Organisation (CSO) suggests that high interest rates have impacted manufacturing and construction, dampening overall growth. The industrial sector downswing also continues.

3) Indian stock market volatility/correction continues. The Bombay Stock Exchange represented by SENSEX grew by 290 per cent in the last 42 months as it moved from around 6000 points to 21000 points. However with continued global slowdown and uncertainties (e.g. subprime crisis etc) the SENSEX went into a correction mode (since January 2008) and is currently trading below 16000 points i.e. at almost a 30% discount. This volatility also led to some companies withdrawing from the primary market after the IPO (Initial Public Offerings) failed to attract enough capital.

4) The government is planning to create a multi-billion-dollar sovereign wealth fund, a first of its kind in India, which aims to invest in energy assets such as oil, gas and coal across the world.

5) Inflation on its way up. Inflation that was reined in by a slew of monetary and fiscal policy measures has started creeping up. It moved from below 3.5 percent in January 2008 to 5.02 percent in March 2008.

Detail

General Budget 2008-09

6) Strong economic growth and buoyant tax collections have given Finance Minister P. Chidambaram room to offer incentives and concessions to a wide range of constituencies in the General Budget 2008-09. For the urban middle class there is the reductions in taxes and excise duty cuts (on some products) while for the rural indebted farmers there have been a debt waiver scheme with a capital outlay of Rs.600 billion. While Budget 2008-09 provides a boost to consumption, but increases the risk of a higher fiscal deficit

7) Investment demand has been strong. But there have been concerns over flagging consumption growth, even as there is a slowdown in the global economy. The Budget attempts to stimulate consumption by putting more money in people’s hands and by cutting excise duties on items such as small cars and two-wheelers. The increase in tax exemption limits and changes in the slab structure will give the middle class more purchasing power; this should boost consumption.

8) Increased government spending however continues to pose risks to the fiscal situation. On the surface, deficit targets for 2007-08 have been comfortably met: The revised budgetary estimates peg the revenue and fiscal deficits at 1.4% and 3.1% of the gross domestic product (GDP), respectively. However, if one adds to this the off-balance-sheet liabilities (subsidies) from oil, fertilisers, and food, the fiscal deficit is estimated at a more substantial 3.7% of GDP. Moreover the fiscal impact of the debt waiver for farmers of Rs 600 billion is not completely clear and in 2008-09, there is likely to be the additional impact of the implementation of the 6th Pay Commission. All these may ballon the fiscal deficit number to around 4%. Maintaining the momentum of revenue buoyancy would therefore be extremely critical.

9) Slow growth in the farm sector and growing indebtedness and suicides in rural India have been a cause for concern. But the debt waiver creates a significant moral hazard for existing and future borrowers. It could lead to uncertainty in the banking system.

14) The expansion of the National Rural Employment Guarantee Scheme to the whole country (596 districts), with an outlay of Rs160 billion, would create more jobs for the rural poor. Education and health care are other focus areas. The establishment of more institutes for higher studies, 16 Central universities, and the proposed linking of all knowledge institutes through a broadband network would all help increase the pool of employable workers. The government’s thrust on education should yield long-term dividends.

10) The Budget did not have much for industry. The 2-percentage point reduction in the CENVAT rate, and excise duty reductions on some products should bring some cheer to the manufacturing sector. The reduction in Central Sales Tax to 2 percent is also a good move towards an integrated goods and services tax. The proposed national fund for reforms in power transmission and distribution and the higher allocation for the National Highway Development Programme signal a commitment towards infrastructure development. Industry however was disappointed that the corporate tax level was not reduced and regretted the Finance Minister’s continuing dependence on industry.

11) The proposed measures to deepen the secondary market for long-term debt are a strong positive: the ambitious infrastructure projects proposed in areas such as power, urban infrastructure, etc., will require large amounts of long-term debt. Moves to improve the tradability of corporate bonds, remove tax deduction at source on listed debt securities, launching exchange-traded currency and interest rate futures and developing a transparent credit derivatives market are steps that have been identified by various committees/reports including the Mumbai IFC report.

Economic Survey 2007-08

12) Economic Survey (ES) is brought out by the Finance Ministry and speaks the mind of the government. This also gives a direction on various issues that government intends to tackle in the coming year. ES 07-08 talks about necessary reforms required to give a boost to the Indian economy that already has moved on to a higher growth path. The survey points out that managing foreign capital inflows (along with inflation) is one of the key challenges that Indian policymakers will have to face in sustaining economic growth at high levels in the future. It is a given that high GDP growth attracts foreign capital looking for profitable investment opportunities. However, if the growth opportunities do not materialise fast enough, there is pressure on the currency to appreciate, resulting in either an accumulation of reserves (followed by monetary expansion and inflation).

13) Some highlights of the ES 2007-08 are –

• Economy slows down to 8.7 per cent in 2007-08, compared to 9.6 per cent in previous fiscal
• Sets a target of 9 per cent GDP growth during the 11th Plan (2007-2012)
• Projected that inflation would stand at 4.4 per cent during the current fiscal
• Rupee up 9.8 per cent vs. Dollar, since April '07
• Government projects lower agriculture growth at 2.6 per cent in 2007-08 from 3.8 per cent in 2006-07
• Manufacturing sector to grow at 9.4 per cent in current financial year, lower from 12 per cent in 2006-07
• Outlook for exports in 2008-09 may not be as bright due to global slowdown and exchange rate development
• Foreign reserves at US$ 290.8, up by US$ 91.6 billion from a year ago
• Total foodgrain production marginally high at 219.3 million tons in 2007-08 from 217.3 million tons last year
• Talent shortage leading to high attrition and rising wages, contributing to cost-push inflation
• The Economic Survey favours liberalising debt and currency markets; removal of constraints on agriculture and urban land supply
• Export growth at 20.3 per cent in 2007
• Number of telephone connections at 272.88 million as on December 31, 2007; tele-density at 23.9 per cent
• The government has set an ambitious target of providing 200 million telephone connections in the rural areas by the end of 2012
• The rate of growth of per capita income has sharply climbed to 7.2 per cent p.a. - implying that average income can virtually double in a decade
• India April-Nov '07 FDI at US$ 11.14 billion
• Government should raise FDI in insurance, retail
• Greater debt and equity issues in primary market

Railway Budget

14) The Indian Railway Minister Lalu Prasad Yadav presented the railway budget, betting on higher investment for growth and modernisation. A buoyant economy has helped the Minister better most of his estimates for the current financial year with a record cash surplus. With an eye on elections the Minister announced a 5 per cent cut in freight rates on petrol and diesel and a token drop in fares for all classes of passengers. The Minister announced some big ticket railway projects which would mean investments over Rs 750 billion in the next seven years for creating new capacities on high freight traffic routes and also a 1,000-Mw power plant in collaboration with NTPC (National Thermal Power Corporation). The Minister also said that the Railways would launch Public-Private Partnership projects worth Rs 1000 billion in the next five years to upgrade stations, set up brand new rolling stock facilities and a multi-modal logistics park.

As can be seen from the figure most of the expenditure went towards salaries (railways has the largest workforce in India) with a negligible portion assigned to rail safety (a percent). The budget also talked about involving the private sector for developing railway stations. This is the first time that railway have decided to go into the PPP mode for development.

Macro economy – signs of slowdown?

15) Strong indications of a slowdown in 2007-8 emerged from the government’s advance estimates today that put gross domestic product (GDP) growth at 8.7 per cent, raising concern over whether the Indian economy could sustain growth at over 9 per cent in 2008-09. However, CSO growth estimate is still higher than the Reserve Bank of India’s forecast of 8.5 per cent GDP growth for 2007-08 but lower than Finance Minister P Chidambaram’s prediction of 9 per cent. The Planning Commission has targeted an average GDP growth rate of 9 per cent during the 11th Plan (2007-12). Describing the GDP numbers as lower than expected, the finance minister nevertheless said he is "disappointed but not despondent" adding that he is reasonably confident that the figures may be revised and economy will grow at close to 9 per cent in 2008-09. Agriculture is expected to grow at 2.6 per cent in 2007-08, while the industry and services sectors, which together account for over three-quarters of GDP, are projected to grow at 8.6 and 10.6 per cent, respectively. Joshua Felman, IMFs Indian resident representative commenting on the slowdown said "The pace of economic growth is in line with growth in potential output. We have estimated that the economy’s potential growth rate is between 8 and 8.5 per cent and it will continue to grow in that range". He was however optimistic that the growth story is set to continue and cited the very high investment numbers in the current year as a proof that industry is expanding and expanding fast.

16) India's industrial output measured by the IIP (Index of Industrial Production) grew by 7.6 percent in December, far below last year's double-digit expansion of 13.4 percent even as the finance minister renewed calls for easier credit to spur the economy. According CSO the industrial growth in Asia's third-largest economy was up from November's revised figure of 5.1 percent but sharply down from the 13.4 percent expansion logged in December 2006. This was on account of widespread deceleration in manufacturing, mining and electricity, among other sectors. The slowdown in industrial growth though is limited to the consumer side while the capital goods sector remained resilient.

Stock markets - Is the market bull run finally over?

17) Soaring returns from India’s bellwether equity index, the Sensex, made it the toast of global investors in recent years. These days, investors betting on the same Bombay Stock Exchange’s index are being toasted. The Sensex has lost at least 21% so far in 2008 alone, the biggest loser among major Asian indices. However, even after the correction, the average price-earnings (PE ratio) multiple of Sensex stocks is at a high 21.58, the second highest in Asia behind China. The P E of China’s benchmark index, which is down 18.27percent (in the current financial) is pegged at 36.03.

18) In January 2008 (when SENSEX was reigning at near 21000 levels) Reliance Power had come out with its mega IPO (Initial Public Offer). The IPO at USD 3 billion was oversubscribed 73 times. By the time the IPO was listed the correction had set in and the stock listed at a 17 percent discount. Wary of similar treatment, Indian companies (e.g. Wockhardt Hospitals and Emaar MGF) are now joining the growing list of Asian firms that have deferred or withdrawn their IPO plans for this year. More than half of the 30 Indian IPOs slated for 2008 have already been postponed.

Sovereign Wealth Fund for meeting energy needs?

19) The Indian Government has finally decided to set up a Sovereign Wealth Fund by using the large piled up forex reserves. While the Planning Commission Adviser (Energy) Surya P Sethi said the plans are still in initial stages, he did indicate that the fund which will have a corpus of a few billion dollars (he did not indicate exactly how much) will invest in overseas energy assets like Temasek of Singapore does. He indicated that while the country has piled up large forex reserves for sucking liquidity there is no additional gain from this piled up resource. These reserves in fact add up to costs – sterilisation costs, which up to a point are justified and beyond a point one needs to find other ways to earn revenue from these. According to the latest data available with the Reserve Bank of India, the country’s foreign exchange reserves stood at about $301 billion at the end of February 2008. (Comment – While such a move would certainly be advantageous, we did hear about this almost six months back when a team from BoE and BHC met the RBI’s monetary policy advisor. The idea however had not gained momentum since then as the MoF was not much inclined to the idea. Remains to be seen how the Planning Commission pushes this, as one of the main concerns of the booming Indian economy today is sufficient and sustainable energy to sustain current economic growth. Again looking at the long term perspective, it is also worth considering that the sovereign wealth fund invests in renewable energy technologies, which have far greater advantages in terms of impact on environment and health of humans, costs and long term potential in comparison to conventional exhaustible energy sources).

Inflation – source of worry

20) The Indian government (MoF) through fiscal policy measures and the RBI through its tough monetary policy stance had reined in inflation for the past six months. During this period the government also did not hike the fuel despite a steep rise in the international crude oil prices. In February 2008 however, the government finally decided to hike the petrol prices by Rs 2 and diesel prices by a rupee. With this passover prices of essential commodities have started moving up and inflation that was reining at 3.5 percent has touched a high of 5.02 percent. The political establishment is not going to be happy with this. A please all budget aimed a wooing electorate would be neutralised if inflation is not This is likely to cause of worry for the RBI as well as the political establishment).

D J Rao

British High Commission

New Delhi