Thursday, February 28, 2008

India at risk of missing economic goals

Palaniappan Chidambaram, India’s finance minister, on Thursday admitted that the Indian economy was coming off the boil in a pre-Budget Day speech that highlighted the downside risks to growth from a possible recession in the global economy.

The finance minister predicted growth of 8.7 per cent in the financial year ending on March 31, down from 9.6 per cent the previous year, and warned of a possible resurgence of inflation.

”Keeping inflation under control will be one of the major challenges in 2008/9,” Mr Chidambaram said, after releasing the government’s annual Economic Survey, a report card that sets the backdrop to Friday’s budget.

The slowdown means that India is falling behind in its goal of sustaining an average growth rate of 9 per cent in the Eleventh Plan, which covers the five years from 2007-08 to 2011-12. The plan predicts Chinese-style double-digit growth in its final year.

Mr Chidambaram said he remained confident of meeting the 9 per cent target, but warned that India needed to invest more in its infrastructure if it were to grow without triggering a return of the high rates of inflation seen in late 2006-7.

Friday’s budget is expected to be populist in tone. It is likely to be the last full budget before the Congress Party-led coalition government – the United Progressive Alliance – faces voters in a general election due to be held by early next year.

The Congress Party is showing signs of electoral nerves. Its poor performance in all five state assembly elections held last year has increased pressure on Mr Chidambaram to deliver an electioneering ’people’s budget’.

Some Congress leaders see the budget as a last chance to buy votes with handouts aimed at softening the sting of widening inequalities between rich and poor, urban and rural areas and upper and lower castes.

Combined with a looming public sector pay review, this could set back the limited progress India has made in reducing its fiscal deficit and public debt over the last five years, during which growth has averaged a record 8.7 per cent.

”The public finances would be vulnerable to the cyclical slowdown now underway in the economy, as well as the outcome of the Sixth Pay Commission,” noted Robert Prior-Wandesforde, an HSBC economist.

”As such, there doesn’t appear to be a strong economic case for an aggressive easing of the fiscal stance” in the budget, he said. “Nevertheless, with the general election fast approaching, it would probably be naïve to expect an entirely neutral fiscal package.”

Economists expect Mr Chidambaram to announce an upward revision in income tax exemption thresholds that remove many people on low incomes from the tax net altogether, as well as further tax rebates for exporters hit by the rise in the rupee.

Including off-balance sheet expenditures on oil, food, and fertilizer subsidies, Morgan Stanley estimates the underlying central government fiscal deficit in 2007-8 will be 5.4 per cent of GDP, rather than the government’s headline estimate of 3.2 per cent.

Weak coalition governments have contributed to a decline in the quality of government spending. Expenditure on development is declining as a percentage of total spending in line with the share of seats in parliament held by the largest political party, according to Morgan Stanley’s Chetan Ahya. FT

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