Pacific Money

New Delhi: We Have a Problem

India’s economy is certainly seeing its share of problems. 2013 is looking like it will be a tough year.

India’s twin deficits – the current account and the government budget – continue to weigh upon and complicate policymaking in the country. A series of recent measures shows New Delhi trying to maneuver in the straitjacket created by this position, but other looming problems promise that the year ahead will be difficult. 

On Tuesday, the Reserve Bank of India (RBI) cut the country’s benchmark lending rate by 0.25%, or 25 basis points, while also lowering the Reserve Ratio (funds which banks have to keep on deposit at the central bank) by 25 basis points.

India’s growth has been falling consistently in recent quarters. As Pacific Money covered in November, Indian economic policy faced a difficult dilemma, with high inflation discouraging the kind of rate cuts necessary to combat falling growth.

The RBI’s governor Duvvuri Subbarao explained the bank’s moves very clearly while also hedging strongly against the possibility of future easing.

The current account deficit, which drags on GDP growth by exporting demand abroad, was also targeted by two more measures focused on gold. Gold, whose value has soared over recent years because of quantitative easing and related inflation fears, makes up a significant portion of India’s current account deficit.  India is traditionally the largest customer for gold, importing $56 billion of it last year.

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Hence, the Indian government raised the tax on imported gold by 50% last week. In order to plug a potential loophole involving gold alloys, a further tax increase on Dore (an alloy of Gold and Silver) saw rates rise from 2% to 5%.  Whether or not these anti-gold import measures bite, the current account deficit in general is set to become a key constraint on any further easing.

The climbing government budget deficit may soon threaten India’s Sovereign Credit rating. Indeed such fears is likely what led Indian Finance Minister Palaniappan Chidambaram to declare “red lines” that the fiscal deficit wouldn’t exceed 5.3% in the current year, or 4.8% next year. As a member of a government facing elections in 2014, these will be tough promises to keep. Monetary easing moves from the central bank are thus a welcome instrument indeed.  Without them, Indian twin deficits and the inevitable debate between growth and austerity would increasingly remind observers of events in peripheral Europe.