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6 | ifr special report | September 2009 ECONOMIC OUTLOOK

To boost exports, Delhi is rolling out aid programmes to help exporters find new markets as it strives to lower India’s dependence on trade with

the US and Europe. Exports account for 25% of GDP, but this is expected to increase as India enters new markets and launches reforms to expand its low-cost manufacturing base (by introducing more flexible labour legislation) to take on China. Economists have applauded Delhi’s stimulus package for working wonders on the economy.

(US$62bn), of which Rs200bn rupees would be new spending. The government lowered taxes and introduced a stimulatory fiscal policy, while the central bank cut interest rates six times to record low levels.

The move has bolstered domestic demand, which accounts for 60% of GDP, revved up factory production and encouraged banks to unfreeze lending to businesses and consumers.

Risky road ahead

The overall outlook is positive but there are some short-term risks that could spoil the economic revival. India faces the spectre of high inflation stemming from its surprisingly quick turnaround. The central bank last month raised its 2009 inflation forecast to 5%, from 4% a month earlier, citing high commodity and food prices. Inflation pressures were further stoked after Finance Minister Pranab Mukherjeee unveiled plans to spend US$93bn improving the country’s infrastructure in July. The move will increase the budget deficit to a 16-year-high of 6.8% of GDP, from an earlier forecast of 6%. The action unnerved some economists who said the deficit could trigger a downgrade in India’s credit rating. They urged the government to change its “accommodative” fiscal policy and raise interest rates soon to fight the risk of runaway inflation. One economist said Delhi’s 5% inflation forecast was conservative and was likely to be exceeded due to higher oil, food and other commodity prices. Already, consumer price inflation is running at between 7%–10%, driven soaring high food prices. But Grice was not alarmed and said he did not expect inflation to rise to unmanageable levels. He said the recently re-elected government was capable of handling the inflationary pressures, adding that it would probably not hike rates until October as doing so earlier could reverse the economic recovery.

Jyoti Narasimhan, director of India research at Global Insight, agreed. “The

direction of economic demand and its effect on exports is still a big question mark,” she said. “Tightening too soon will choke up growth at a time when there are uncertainties in the global system.” While the central bank could lift rates in October, she did not expect this to happen until January when the global economic outlook became clearer. Narashiman said India’s ballooning budget deficit was a manageable short to mid- term risk but urged the government to implement reforms to tackle it as soon as possible. It should look for ways to increase revenues and taxes, while reducing large state and government expenses, including high civil servant pay, she said. Still, she did not envisage the current deficit triggering a rating cut on Indian credit as the economy was improving and “they’ve never had problems financing their debt”.

Infrastructure spend crucial Economists expect India’s GDP to grow 7%–7.5% in 2010 as the economic recovery solidifies and private and public spending increases. Still, many do not expect Delhi to reach its desired 9% annual GDP growth target unless it improves infrastructure and creates a better investment climate. That possibility brightened after the May 16 re- election of Prime Minister Manmohan Singh in a landmark victory which gave his party more power against Communist opponents blocking his capitalist reforms package.

Singh has been a pivotal figure in India’s recent economic boom. As finance minister in 1991, he introduced a plethora of free-market policy reforms that marked a departure from India’s long-running central planning, helping the economy quadruple in size.

With Singh reinstated, many expect these reforms to continue, notably major asset sales of state corporations as well as other initiatives to lift curbs on foreign investment. Mukherjee’s spending programmes are part of that plan.

Financed though future asset sales and a tax overhaul, it is directed at improving jammed ports, stressed power grids, rickety roads and other poor infrastructure that shaves about two percentage points off the country’s growth rate. Grice said the government had done a good job at increasing spending with the investment-to-GDP ratio leaping to 35% from 20% a decade ago. However, he said Mukherjee needed to do more develop infrastructure and improve the business environment to foster private and foreign investment.

“They need to create an environment where the private sector can take a higher percentage of future investment and this won’t happen unless they do a massive infrastructure investment,” he said.

Easing the burden

According to another economist, India is one of the worst emerging markets in which to do business, which is something else that needs to be addressed. “More than in China, it’s difficult to do business in India,” he said. “Setting up a business is complicated, while inflexible labour markets make hiring and firing workers difficult. The legal system is also very problematic, full of red tape and unreliable.”

He added that “there is lots of money to be put to work in India but this won’t happen unless there is a new round of reforms to mobilise funds from foreign and local investors.”

Perhaps then will India achieve its long- term ambition of becoming a major world power. Some economists said India could overtake Britain to become the world’s fifth-largest economy within a decade if it can repeat the huge growth rates of past years. The country could also eclipse the US by 2050, becoming the world’s second- biggest economy after China. But given that India’s power cuts continue to rise, while many of its roads are pot-holed and crumbling, those dreams may take longer to be realised.

Ivan Castano

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