Early India poll to put fiscal targets at risk

NEW DELHI—Signs India’s ruling coalition is loosening its purse strings to shore up voter support as a political impasse points to early elections could jeopardise a target to reduce the federal fiscal deficit. The budget gap has almost halved to 3.5 percent of gross domestic product in 2006/07 from five years earlier as a rapidly expanding economy boosted government revenues.
But an expected hefty pay rise for government workers, plans to keep fuel prices low, and new welfare schemes for India’s poor — a massive voter bloc — could inflate the deficit again. If such populist spending goes unchecked, the fiscal deficit will swell back above 4 percent of GDP, analysts say, especially as economic growth is seen slowing from the blistering 9.4 percent pace in the year to the end of this March — the fastest growth in 18 years.
“Most of the steps taken by the government in the recent past would be negative from a fiscal deficit perspective,” said Harish Menon, economist with ING Vysya Bank. “But the think-tank are probably counting on a higher GDP base to achieve the fiscal responsibility and budget management targets,” he said, referring to the finance ministry.
The fiscal responsibility acts binds the government to cut the federal deficit to 3 percent of GDP by 2009, but early elections could mean abandoning prudent economics in favour of populist spending. Slowing growth and higher spending would force the government to rely more on borrowing, which could push up local interest rates.
So far the government bond market has not shown too much concern about the spending plans, focusing instead on the prospects of another increase in bank reserve ratios as the central bank fights a fast-rising rupee. But analysts say market concern about the budget deficit could grow if an early election looked more likely. The next election is due in May 2009 and an early election is by no means certain. But speculation of one has mounted after nearly two months of deadlock between Prime Minister Manmohan Singh’s government and its communist allies over a nuclear energy deal with the United States.
The fiscal deficit has narrowed in recent years largely because quicker economic growth boosted revenues, rather than owing to spending discipline or reform. Growth has averaged 8.6 percent over the last four fiscal years. A Reuters poll showed economists expect growth in Asia’s third-largest economy to moderate from more than 9 percent in the last fiscal year to 8.5 percent in 2007/08 and 8 percent in 2008/09 as tighter monetary policy takes effect.
Analysts say the coalition’s populist tendencies of late included announcing a health insurance scheme for the poor that will cost $190 million a year. It widened a rural job guarantee plan, which is now expected to cost $5 billion a year. The government has also made more civil servants eligible for bonus payments.
And despite record international oil prices, the government has resisted increasing state-set retail petrol prices. “Recent decisions suggest that government may be getting into election mode,” said A. Prasanna, economist with ICICI Securities. “Going forward, it is highly probable that the government goes slow on contentious issues and resorts to doses of populism.”
The greatest dent to government coffers is likely to be pay increases to 3.4 million of its workers. A government panel, set up once a decade to assess civil servant salaries, is expected to propose an increase of up to 30 percent when it submits its report next April, although the timetable could change.
“Early elections could even prompt announcement of some recommendations ahead of schedule,” JP Morgan economists wrote in a note last week. “Note that the recommendations of the (previous) pay commission ... and its lopsided implementation was considered the largest ever adverse shock to India’s public finances.” A similar panel in 1997 raised government workers’ salaries at an annual cost of $13 billion. State governments were forced to match the pay rise for their workers, blowing out the combined central and state deficit to nearly 10 percent of GDP.—Agencies