India’s Spending Plan May Be Too Little to Prevent Slowdown

By Cherian Thomas

Dec. 8 (Bloomberg) -- Indian Prime Minister Manmohan Singh’s spending plan and interest rate cuts unveiled over the weekend may not be enough to prevent economic growth slowing to the weakest pace in six years, economists say.

Singh plans to allocate an extra 200 billion rupees ($4 billion) as part of a total 3 trillion rupee spending plan for the rest of the financial year ending March 31. The Reserve Bank of India on Dec. 6 cut rates for the third time since October.

The size of the incremental expenditure, representing 0.3 percent of the gross domestic product, indicates the government wants to rely on monetary policy to stimulate growth. Lower interest rates will allow Indian companies to turn to local banks for funding rather than rely on lenders in the U.S. and Europe, where credit has dried up for many borrowers.

“No matter what steps India takes, they are unlikely to prevent growth from sliding next year,” said Tehmina Khan, international economist at Capital Economics Ltd. in London. “Investment spending, the main driver of growth in recent years, has been hit hard” because of the rout in stock markets and the liquidity squeeze overseas.

Forty percent of Indian industry’s funding in the year ended March 31 this year, when the economy grew at 9 percent, came from overseas borrowings and the sale of new shares in the stock market, Khan said.

In the year to March 31, 2009, “the moderation in growth will be more than anticipated,” Governor Duvvuri Subbarao said while announcing the rate cuts. He said the 7.5 percent growth forecast for the current year will be revised in the next monetary policy statement scheduled on Jan. 27.

Fiscal Steps

Subbarao said Dec. 4 that lower borrowing costs need to be augmented with fiscal steps to spur consumer demand. The amount Singh can spend is limited by the size of the government’s public debt, which makes up about 77 percent of gross domestic product, compared with 22 percent in China.

China unveiled a $581 billion spending plan last month to help its economy expand more than 8 percent for each of the next two years. Domestic consumption only accounts for 37 percent of Chinese GDP.

India, where domestic consumption makes up 60 percent of GDP, is being buffeted by the global recession because its integration with the world economy has been on the rise. For example, the volume of trade rose to 35 percent of GDP in the year ended March 31 from 21 percent in 1997-98, the year of the Asian financial crisis, according to the central bank.

Boost Needed

“India must give its economy as much boost as it can at this point,” said Sherman Chan, an economist with Moody’s Economy.com in Sydney. “No country, including India, can escape the impact of the global recession.”

India’s exports fell 12.1 percent in October, its first drop in seven years.

The country’s economic woes have been compounded by the terrorist attack on luxury hotels, a cafe and other places in its financial capital of Mumbai on Nov. 26, killing 163 people. The attacks prompted Merck KGaA, Daiichi Sankyo Co., GlaxoSmithKline Plc and Sanofi-Aventis SA to halt business trips to India.

Services such as hotels and travel will be hurt after the attacks, said Deepak N. Lalwani, director for India at Astaire & Partners Ltd., a London-based stock broking company.

Low Rates

Budget constraints are forcing India to rely more on interest-rate cuts to buoy the economy. India will forego about 87 billion rupees in revenue because of the 4 percent cut in central valued-added tax announced yesterday in the stimulus plan, Finance Secretary Arun Ramanathan said.

India’s debt sales in December will exceed its initial plan because of additional spending commitments, the finance ministry said on Dec. 5. The federal government will sell 100 billion rupees of bonds this month, or 70 billion rupees more than it had planned earlier.

Subbarao reduced the central bank’s repurchase rate for the third time in less than two months on Dec. 6, to 6.5 percent from 7.5 percent. He also cut the reverse repurchase rate at which it borrows overnight, to 5 percent from 6 percent, the first reduction since 2003.

Governor Subbarao’s move was made easier after the government reduced fuel prices by as much as 10 percent on Dec. 5, which may further drive down inflation from the current seven-month low of 8.40 percent.

Oil Prices

“The drop in oil prices is really important positive news for India,” Jim O’Neill, chief economist at Goldman Sachs Group Inc. in London, said in a Dec. 1 interview. “I am reasonably optimistic about India.”

Lower central bank rates may prompt non-state lenders, including ICICI Bank Ltd., to charge less. Only state-run banks, which control half the assets in India’s banking sector, have lowered their prime lending rates following the cuts in central bank rates since October.

“Merely making the environment more conducive won’t be enough,” said Prasanna Patankar, head of fixed-income trading at Securities Trading Corp. of India Ltd. “The growth momentum will take a few months to get moving fully.”

To contact the reporter on this story: Cherian Thomas in New Delhi at Cthomas1@bloomberg.net.