Tags: India | rupee | Modi | deficit

India – A Complicated Story With Upside Drift

By    |   Wednesday, 06 August 2014 08:06 AM

India held a historic election in May. The results were epic as well. After nearly three decades, they had a clear mandate for the incoming government to rule without the pressures of coalition and divergent agendas.

The Bharatiya Janata Party (BJP) led by the charismatic Narendra Modi swept the nation and relegated the Congress party to a completely decimated status where it cannot even claim the mantle of leader of opposition, as it does not have enough seats to claim that title.

The two aspects of the campaign that Modi fought that I found dubious was his claim that he will defeat inflation and that he is not going to succumb to Hindu nationalistic intolerance. He personally has been accused of ignoring riots in his home state of Gujarat where Muslims were massacred by Hindu hooligans when he was chief minister of the state. He was never convicted of the crime but the United States had denied him a visa for a decade for that reason.

Now that he is in power of the whole country, he has gotten off to a shaky start. While he has tried to install some discipline among his ministers, he has not quite been able to stave off inflation as easily as he had touted during election speeches. Inflation still hovers around 8 to 9 percent, according to official statistics.

On the front of running a secular country, he has not made much progress either. The recent verdict of the government bowing down to a student-led protest to eliminate English from the central exams to qualify for government positions reeks of a disguised, back-door attempt at imposing Hindu rule by denying students the need to study English. It is certainly a step in the wrong direction.

On the right side of things, the 2014-15 budget has claimed to take a serious approach at reducing the twin deficits that plague growth in India. The very high fiscal deficit has led to rampant inflation, a drop in savings rates and a misallocation of spending. In this context, the new government's path of aggressive fiscal consolidation announced in the budget could potentially have large macroeconomic consequences.

By raising taxes on the people, we can assume (under a Keynesian approach) that there will be a decline in GDP growth, as people have less money to spend due to higher taxes. A recent International Monetary Fund paper suggested that a 1 percent fiscal consolidation leads to a drop in GDP of 0.6 percent and reduced private consumption by 0.75 percent within two years.

I do not believe this will be the case in India. If we pare down further the methodology laid out by the government of how it plans to reduce the fiscal deficit, we can see a clear strategy of reducing current spending and increasing capital spending. For a long-term strategy this is a good move. As investments in Indian capital goods and infrastructure grow, we can see a definite shift in the deficits as they will decline. Now I do not believe that they will hit all the achieved targets, but I believe they are headed in the right direction.

As a result I am cautiously bullish on the prospects of growth at a systemic level in India in the next few quarters.

I am also becoming cautiously bullish on the Indian rupee. Here are three reasons why I believe the rupee could rise:
  • Reduction of deficits will put the Indian sovereign risk on a stronger footing leading to a drop in the country risk.
  • Improved fiscal discipline and longer-term stable policies will lead to higher savings rates and invite more investments to the country, leading to lower current account deficits.
  • A controlled spending plan will reduce the needs for the government to issue new bonds and as the reduction of public debt plays out in the market, we will see a strengthening of the rupee as less is floating around.
Now many things can go wrong here, but I believe we are off to a good start. I would consider adding the rupee to my investment diversification effort, but keep a wary eye on any reversals of fortunes here.

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India held a historic election in May. The results were epic as well. After nearly three decades, they had a clear mandate for the incoming government to rule without the pressures of coalition and divergent agendas.
India, rupee, Modi, deficit
Wednesday, 06 August 2014 08:06 AM
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