good times ahead for the Indian economy and markets

FM on over-drive to remove downside risks on the Indian economy and markets

The recent developments from the Finance Ministry are very encouraging, and have helped to remove the fear factor (and downside risks on the economy) from much talked about issues of policy paralysis, twin-deficits and growth. The Finance Minister has indeed taken the bull by its horns in the absence of RBI support. He had the worry that Government had to walk alone, which has now turned into a sprint to cut lag time. The efforts towards addressing top priority items are commendable. The immediate focus is on attracting long term off-shore investments while keeping the FII interest in tact; drastic reduction in fiscal deficit and squeeze the current account deficit gap; all these will help to contain inflationary pressures and prepare RBI for aggressive growth-supportive monetary stance. The move to link bulk fuel purchases to market rates and gradual price hike over 18 months period on retail purchases provides great comfort on fiscal consolidation over medium to long term. The international road-show of the Finance Minister post the deferral of GARR will help better bonding with the foreign investors to attract sufficient off-shore funds into debt & equity capital market to bridge the Current Account deficit. While the fuel price hike will cut consumption of essential import, the move to tax non-essential imports will help bridging the gap in Current Account deficit on its own. It is also seen that political consensus is reached on fiscal deficit; political resistance was not visible post the announcement of this strategic plan to remove fuel subsidy from the expense item of the Government’s balance sheet. If this consensus can extend to policy reforms, there is great story ahead for the Indian economy and markets.

The need of this aggression to address fiscal concerns emanate from limited bandwidth to extend monetary support to growth. The vicious cycle of growth-inflation dynamics and high dependence of one on the other is seen to be cut. The strategy now is seen to be clear; set the fiscal position in order to remove supply side bottlenecks and cut inflationary pressures on the system and demand favourable monetary policy from RBI, who has made it clear that loose monetary and fiscal policies cannot co-exist. The system may need to be prepared for a slow but steady shift into growth supportive monetary policy stance; however, timing of the shift is not clear but seen to be not later than April 2013. The high headline CPI inflation print and impact of cut in fuel subsidy on prices of essential items may push RBI to delay the shift into rate cut cycle. The Finance Ministry may see prudence in the approach for long term beneficial impact. Despite this disappointment from this short delay, there are lot of positive take-away from recent developments. There is significant dilution in the fear of sovereign rating downgrade; bearish set up on rupee exchange rate is diluted; signs of strong tailwinds from monetary and fiscal policies to growth momentum in the medium term and all these factors driving the investor (and consumer) confidence strongly up for capacity expansion of the Indian economy. There are strong signals that good times are not far away!

Moses Harding