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FM's Budget Blues
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Having failed to cut its subsidy bill, the UPA government is widely expected to miss by a long chalk its deficit target of 4.6 per cent of GDP for the fiscal year that ends in March.
The easy option would be for the finance minister to sneak in reforms that don't need parliamentary approval, such as raising fuel prices or permitting more foreign holding of Indian bonds.
With global crude prices touching a new high on mounting geopolitical tensions, subsidy payout for the next year is only expected to rise unless pump prices are raised.
The Congress party's drubbing in Assembly elections proved beyond doubt that its populist politics failed to resonate with voters, and yet investors and consumers alike are bracing for more of the same from the besieged ruling party.
"This setback might be the final push to convince the UPA to bring in critical supply-side reforms to improve economic prospects," analysts at Standard Chartered Bank said in a note.
Before the global financial crisis of 2008, India's growth capacity was estimated at around 8.5 per cent. But a lack of economic reforms since then has shaved that growth potential to a 7-7.5 per cent annual pace.
"There is a risk that the government might opt for a more populist budget and rethink any possible decisions to trim subsidies - which might hurt their support base at the grassroot level," said Radhika Rao, economist, at Forecast PTE in Singapore.
"The coalition administration will be hard at work in the run-up to the parliamentary elections in next two years, with odds skewed for another overshoot in 2012-13 fiscal deficit, at least over 5.0 per cent of GDP."
Populist Policies Fail
Hemmed in by maverick allies and the fallout from a slew of corruption scandals, the Congress party-led central government has failed to carry out any meaningful structural reforms since it was re-elected in 2009.
Investors had hoped a strong performance in the elections would ease political constraints on Prime Minister Manmohan Singh, giving him room to revisit politically contentious reforms.
"As things stand now, they won't be able to bring any reforms. Their own allies will oppose everything," said D. H. Pai Panandiker, who heads Mumbai-based think-tank RPG Foundation.
There is a considerable room to improve the business environment in India and boost the corporate investments through measures like lowering of costs and better financial access, an IMF Working Paper has said.
"The results will not provide the political space for the government or the confidence to carry through unpopular reforms," Goldman Sachs said in a note. "We think the best that can be hoped for is muddle-through policies by the government."
Noting that the corporate investments have slumped to 10 per cent of the national economy, from 14 per cent prior to the global financial crisis, the IMF Paper has said that the corporate profitability could also be given a boost through measures like economic reforms and lowering of business costs.
"Cutting various costs of doing business and improving financial access" can help in providing the boost to corporate investments and the country has considerable room to improve its business environment, it noted.
Some reforms, such as land acquisition and foreign investment rules, and the sensitive issue of subsidies on fuel, are crucial to lifting investment and spending in an economy headed for its slowest growth in three years.
Tuesday's poll results, showing Congress fared badly in four of five states, altered the odds of any such push for reforms in the budget.
Rather than becoming the catalyst for a renewed reform push, the state elections would provoke more populism, was the consensus view of analysts.
That is likely to mean more spending on social programmes, such as a pledge to provide universal food security that could bleed public finances but help Congress' general re-election bid in 2014. The budget for the fiscal year that begins April 1 will be unveiled on March 16.
Low Business Ranking
Last year, India was placed at the 132nd position among 183 countries in terms of ease of doing business. Even though the ranking was better than in 2010 (139th spot), it reflected relatively high costs of doing business.
"... India could enhance corporate sector profitability by reducing doing business costs, reforming regulation, improving institutions and developing infrastructure," the paper noted.
As per the report, high and volatile inflation and heightened global uncertainty might have dampened corporate investment.
"While monetary easing since the global financial crisis provided important support for corporate investment, the monetary tightening since early 2010 may have started hurting corporate investment at the margin.
"The main policy implication of these results is that lowering and stabilising inflation is critical for sustained investment growth," it added.
Indian economy expanded just 6.1 per cent in the 2011 December quarter, the slowest growth in more than two years, mainly on account of high interest rates and global demand slowdown.
After the Assembly elections, Singh's government was widely expected to implement a decision to open India's $450 billion supermarket sector to foreign firms such as Wal-Mart Stores Inc. It had been forced to backtrack on that policy late last year in the face of a strong political backlash.
New Delhi is also considering raising domestic fuel prices in order to ease its subsidy burden, a politically unpopular move for which it may not have the stomach.
"People are worried now that the government will make a compromise in the budget," said Taina Erajuuri, a Helsinki-based portfolio manager at FIM India. "The worry is that the government will increase the social expenditure at the cost of reforms. Foreigners do not want to see that."
The BSE Sensex fell more than 1 per cent on Tuesday to its lowest close in more than five weeks, and a further half per cent on Wednesday, although the declines were broadly in line with other Asian markets and BSE Sensex remains up more than 10 per cent for the year-to-date. The rupee posted its biggest single session fall in six weeks on Tuesday.
Federal bonds failed to rally despite the Reserve Bank of India's plan to buy a higher-than-average amount of debt this week as a negative outcome for the Congress party doused hopes of a credible fiscal consolidation roadmap.
Resistance To Reforms
It's one thing for the ruling United Progressive Alliance (UPA), which is led by the Congress, to admit its policies centred around handouts and higher rural wages have failed. It's quite another to try and push for higher taxes and transparency in the face of an energised opposition and squabbling coalition.
Still, several analysts reckoned the Congress leadership will see the writing on the wall, leaving it little choice.
"It's time for Congress to perform or perish," said Arun Kejriwal, strategist at Mumbai-based advisory firm KRIS, arguing for the government to put in place policies that may encourage business and create more jobs for voters.
"If this budget doesn't give any direction to the economy, Congress is likely to find itself in a mess in 2014, because next year's budget would be too late to do anything substantial for the economy," he said.