Economic Highlights

New Delhi, 4 January 2013

US Fiscal Cliff

INDIA MAY NOT BE SPARED

By Shivaji Sarkar

The world is agog with the US fiscal cliff – hike in taxes and cut in expenses. But few realize India is in no less a difficult situation. Quietly the expenses cut are being enforced in many sectors. The latest to join among these are defence and education.

The Government has decided a Rs 10,000 crore reduction in defence budget. Education is set to lose an allocation of about Rs 3500 crore. Health care is unlikely to see any increase. Even the populist MNREGA programme may not see any raise.

Many other heads may meet the same fate as Government deficit continues to rise, current account –trade deficit becomes critical, revenues stagnate, non-productive expenses rise and rupee slides. The decision to hike tax on gold import may have impact on the jewellery industry, which is sustaining itself on a low margin amid global competition.

Besides, America’s budgetary cut would have an impact on many areas of business which have exposure to the US. Despite a reassuring statement from NASSCOM, the software industry is likely to face a difficult situation. The companies may remain in business but they would be creating more jobs in the US rather than in India.

Although India does not have much dependence on the US, a possible downturn in that country is going to hit the world economy, particularly in the backdrop of fragile economic conditions in Europe and China. This will certainly have its impact on global markets as it would have a telling affect on the sentiments and liquidity (foreign money flow), both which so far have been supporting the Indian equity markets.

Also there is risk averseness among the investors because of which there has been selling in the market. They are also seeking for more clarity on this issue before committing any fresh money. In the interim, despite all the positive policy announcements, hopes of rate cut and economic news on the bigger issue of fiscal cliff could keep the markets under pressure.

Economists have warned that the US across-the-board tax hikes and spending cuts would have punched a $600 billion hole in their economy this year and threatened to send the country back into recession. This is not a good indicator for the world economy. The European economy would be hit in a more difficult manner to which India has a larger exposure. This apart US spending cuts are likely to slow down the global economy. The big question as to how India would face this is yet to be known.

It would definitely face a major crunch in foreign fund flow. The latest move of the Government in setting up a Cabinet Committee on Investment only manifests the concern about the global investors shying away.

Even mergers and acquisition which hit $ 43.4 billion has more been a domestic affair. India’s inbound mergers and acquisitions have declined. The completed M&A deals involving India declined 62 per cent in 2012 to $ 18.3 billion in 2011. The number of foreign firms acquiring domestic companies also declined in 2012 with 307 announced deals worth $ 15.3 down 24 per cent from a robust 2011 period.

The Indian industry though on record is euphemistic about 2013, has not found much to see a real boost. Some of the industries that were doing well such as automobile and real estate have virtually hit a low.

The US fiscal cliff would also have other problems for India. The uncertain dollar has led to a surge in gold imports as it has become investors’ prime attraction against dollar and bank deposits. Even stocks are losing sheen. Appreciating prices of gold has made it the key investment mode.

This is also an indication of slowing down of activity in the economy. As industrial and manufacturing growth reach plateau, everyone is keen on keeping their money on safe bait. Gold becomes the obvious choice.

The US fiscal cliff was initially expected to impact the dollar and the rupee was expected to mark a rise. It has not happened. The rupee was also hurt by strong dollar demand from oil importers to meet their payment obligations. Unfortunately, the stubborn strength of the dollar is bad news for Indian travelers and students looking to study in West. The dollar-rupee pair is likely to remain in a broad band of Rs 54-56 in the short term, according to currency traders.

India's current account deficit widened to a record high of 5.4 per cent of GDP in the September quarter as export growth slowed more sharply than imports, data released on January 1 showed. As forex kitty is getting thinner, it is further impacting the rupee. The US fiscal cliff is likely to impact India’s exports further. So the pressure on the rupee is likely to continue.

This might also increase inflationary pressure. Undeniably, the intrinsic value of the rupee is eroding. The Government has not taken any steps to stem the situation. Domestic inflation could have been contained with better governance and managing the supply side issues, reduction in the number of government officials, tackling the problems with internal insurgency – now largely restricted to Naxal-hit areas - through a process of political dialogue. More rhetoric has taken place with little efforts to address the issues.

The industry and the Government want the Reserve Bank to cut interest rates. The atmosphere is hardly conducive for it. In fact, the situation is so volatile that the RBI has to tread with extreme caution. More so as the public sector banks are having tough times with large funds lent remain unpaid. Any cut in rates would see further erosion in the strength of the banks.

Rate cuts initiated by the US in 2008 has been criticised by most experts. They called it a free bonanza for the rich and corporate at the cost of the common man. The RBI so far has held on to the pressures. It should not allow a rate cut but must see that the spread between the deposit rate and lending rates narrows. Other bank charges, however, call for a reduction.

Clearly, the US move might lead to two factors at play. A weaker global economy might hurt domestic growth further while lower crude oil prices could ease some of the current pressure on the balance of payments (BoP). That is a small relief and may be only temporary.

The more tricky challenge will be to manage the immediate impact of a global shock if the US economy tumbled over its fiscal cliff. The experience of September 2008, when Lehman Brothers imploded and global financial markets froze in shock, is fresh enough to dismiss any empty hopes that India will be immune from a new global shockwave. ---INFA

(Copyright, India News and Feature Alliance)