India reform may be frustrated by political caution in run up to next year’s election

23rd October 2013

India has had an unhappy year in 2013 but the prospects for reform remain mixed according to experts.

In an economic view from Schroders emerging market economist Craig Botham, he says the new Central Bank governor Raghuram Rajam is planning liberalising measures popular with markets, but government caution before next year’s election may frustrate other reform measures.

Gross domestic product has started badly and is getting worse. Real GDP growth has decelerated, with Q2 growth of just 4.4% year on year, against 5.5% growth the same time last year.

The country is also running deficits on both the fiscal and current account, which have helped to drive an underperforming rupee this year – at one point 26.6% weaker against the dollar than at the start of the year.

“This in turn has created inflationary pressures for a country importing around 70% of its oil and which is the world’s largest buyer of gold.

“The preferred measure of inflation, the wholesale price index, rose 6.1% year on year in August. However, core inflation remained subdued, reflecting the softness of domestic demand and the largely imported nature of the inflation. The mix of slowing growth and accelerating inflation presents a policy dilemma for the central bank”, the note said.

Raghuram Rajan – The new Governor of the Reserve Bank of India

“The selection of Raghuram Rajan as new governor of the Reserve Bank of India raised hopes amongst investors, and he did his best not to disappoint. Beginning his term on the 4th September, the following day Rajan outlined wide-ranging plans for reform and liberalisation, and the rupee responded by strengthening 1.5% against the dollar.”

Election storm clouds gather

“India holds its parliamentary elections in May 2014, and the government is wary of rocking the boat before then. Witness recent populist policy, such as the Food Security Bill, which guarantees subsidized grains to two-thirds of the population. Once fully implemented, the bill will increase overall annual food subsidies by an additional US$5-18 billion (1.1% of GDP) annually.

“What reforms have been announced run counter to the facilitation of investment that India needs. A recent land acquisition bill requires private developers to obtain consent from 80% of displaced people before purchasing land, with increased compensation due. This will increase the time taken to buy land from an already high level. It is difficult to see more positive policies being introduced before the elections.

“As for post-election, it is too early to call, but government by coalition seems likely to continue, most likely led by the BJP, currently in opposition. The polls also seem likely to increase the presence of regional parties, which has already proven to make nationwide reforms more difficult. The hope must be that dire economic performance drives the regional parties to co-operate. The precedent, however, is not promising.”

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