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Rediff.com  » Business » Indian political caution adds to risks

Indian political caution adds to risks

By Joe Leahy in Mumbai
February 15, 2008 09:23 IST
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Anand Sasanwar, a driver who runs a small business ferrying tourists and business visitors around Mumbai, looks like the face of the new India.

From a lower-income family, he has developed his business on the back of India's rapidly expanding economy, last year buying a second car and hiring another driver to help him.

As with many lower-middle and working-class Indians, however, Mr Sasanwar's prosperity is fragile - high fuel prices and vehicle maintenance costs chew up most of his income, meaning that any increase can quickly tip his finances into the red.

So when India's government finally jacked up fuel prices on Thursday after 20 months of deliberation, Mr Sasanwar and millions like him responded with a mixture of frustration and resignation. "I'll have to increase my rates. What else can I do? It's a government decision," he says.

The government increases were modest - at about 3 per cent to 4 per cent on pump prices for diesel and petrol - leading economists to brand them as token in a world where crude oil prices increased by about 50 per cent last year. But the move highlights the conundrum facing the government. India's five-year economic surge is showing signs of losing steam with high interest rates - the benchmark rate is now 7.5 per cent - damping credit growth and a strong rupee hurting exports.

Yet the central bank, the Reserve Bank of India, is loath to cut rates for fear that inflation - which breached 4 per cent in January, the highest in five months - could jump on the back of volatile global food and commodity prices.

That would be a disaster for the political ambitions of the country's Congress party-led ruling coalition, which is gearing up to fight several state elections and a general election within the next 12 months.

Tushar Poddar, an economist with Goldman Sachs in Mumbai, says: "The RBI is facing a dilemma. Growth is slowing and yet inflation is rising. There is not much you can do in a situation like that."

India's gross domestic product rose 9.4 per cent and 9.6 per cent in the past two fiscal years. The government was forecasting another year of above 9 per cent growth in the fiscal year ending March 2008.

So it was something of a surprise when the government's statistics office last week said growth would slacken to 8.7 per cent this fiscal year on steep interest rates that have remained stubbornly high for more than a year.

The impact of the higher rates has struck consumer finance hardest. Growth in new motor loans and mortgages has collapsed, and production of consumer goods has weakened. Again, it is the poor who have been hit hardest, with defaults on banks' small ticket loans, those up to about $1,300 (euro 890, pound 660), on the rise.

Overall, lending eased to about 23 per cent in the 12 months ending in January, from 30 per cent a year earlier.

Until last week, most of the business elite in Mumbai and New Delhi were able to ignore the growing anecdotal evidence of slower growth because of a robust stock market, which continued to reach new highs in early January.

But that changed on Monday when the country's largest initial public offering, the $3bn listing of Reliance Power, bombed on its trading debut. India's benchmark index has now fallen about 20 per cent over the past month. Economists argue that these factors undermine theories that India could "decouple" itself from a slowdown in the world economy and weak sentiment in global markets.

"This is a global phenomenon. People had thought India was immune to it but they weren't looking at the data. Our theme for this year is a very strong recoupling," says Goldman Sach's Mr Poddar.

Concern over slowing growth is fuelling a widening divide between the Ministry of Finance and the RBI. Palaniappan Chidambaram, the finance minister, last month urged banks to lower their lending rates and this week appealed to them to issue more mortgage and consumer loans. Some banks responded with minor cuts in rates but such appeals will largely fall on deaf ears while the RBI continues to keep rates high.

According to Mr Poddar, one of the primary reasons the central bank cannot cut rates much more than a token 25 basis points is because India's central and state governments are continuing to run high fiscal deficits - estimated by Morgan Stanley at 6.2 per cent for the fiscal year ending in March.

Although the headline deficit has declined in recent years the real figure is even greater when off-budget items, such as increasingly expensive fuel subsidies, are taken into account. The effect is to flood the system with money at a time when the central bank is trying to put a lid on inflation.

Few believe, however, that the government will act to curb spending during an election year. The political equation is simple - while growth mostly benefits the rich minority in India, inflation inordinately affects the poor - and in India, it is the poor who vote.

"If your cost of living is 95 per cent of your income and it suddenly becomes 105 per cent, you are dead," says Chetan Ahya, an economist at Morgan Stanley. "These are the people who actually go and vote and the politicians will get a very quick response from them if they do not take action."

Still, no one is predicting Armageddon for India. Growth above 8 per cent will still make it the world's second-fastest growing large economy.

Unlike in the past, Indian companies have low debt and are flush with cash so those not dependent on the stock market for capital will be able to continue investing. "In the worst-case, I expect the impact would be a loss of 1-1.5 percentage points of GDP if the global uncertainties continue," says K V Kamath, chief executive officer of ICICI Bank, the country's largest private sector financial institution.

But some economists warn that in the longer run, even with 8 per cent growth, India cannot afford to be complacent. Rohini Malkani, an economist with Citigroup in Mumbai, calculates that the country needs to grow by a sustained 10 per cent if it is to increase its per capita income, which is the third lowest in Asia after Pakistan and Bangladesh.
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Joe Leahy in Mumbai
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