Deficit Woes Deny Rajan Room to Cushion India From China Turmoil

  • Concerns about budget deficit, inflation complicate RBI's job
  • Governor Rajan warns against competitive currency devaluation

A month after Chinese markets crashed last year, India’s central bank slashed interest rates by 50 basis points to help domestic demand make up for slowing global growth. That move may be harder to repeat in 2016.

Three weeks before his next rate decision, Reserve Bank of India Governor Raghuram Rajan faces inflation that threatens to stay above his 2017 target and a government that risks loosening its budget deficit goals. Foreign investors, which poured $10 billion into Indian stocks and bonds over the past year, have turned net sellers this month.

"We are not looking at any rate cuts in 2016," Sailesh Jha, Singapore-based chief Asia economist at Credit Suisse Group AG, said by phone. "India, which did OK during the last bout of China-led volatility in August, will face accelerating capital outflows."

So far, India has fared better than most emerging-market counterparts. The World Bank forecasts the South Asian economy will grow 7.7 percent in 2016 compared with China’s 6.7 percent pace, while Brazil and Russia both shrink.

Still, Indian equities have been hit along with other emerging markets. Stocks pared their steepest weekly loss in more than four years only after China’s central bank moved to stabilize the yuan on Friday.

“We need to avoid beggar-thy-neighbor policies, such as unconventional monetary policy or sustained exchange-rate intervention, that primarily induce capital outflows and competitive currency devaluations," Rajan wrote in a Project Syndicate column published on Jan. 6. He called for organizations such as the International Monetary Fund to pass careful judgement on each unconventional monetary step taken in the quest for growth.

Rajan, whose three-year term is due to end in September, has dealt with market volatility since he took office in 2013. Back then he stabilized a plunging rupee by offering to buy dollars from banks at discounted rates and vowing to retain confidence in the currency by keeping inflation low and stable.

The government at the time also took action to reduce a budget deficit that reached 4.6 percent of GDP in the year through March 2014. It called to bring it down to 3 percent of GDP by March 2017, a goal Prime Minister Narendra Modi initially endorsed when he took power almost two years ago.

Fiscal Path

The situation now is more uncertain. Most of Rajan’s dollar swaps come due toward the end of 2016, even as export earnings drop for 12 straight months. A scheduled pay increase for government employees and higher military pensions threaten to worsen Asia’s widest budget deficit and stoke price pressures if demand is not matched by more supply.

The need for growth would also drive Indian policy makers, according to Standard Chartered Plc economist Anubhuti Sahay. She expects an interest-rate cut in April after the government presents its budget at the end of February.

Modi’s administration, which abandoned its predecessor’s deficit-reduction path last year, would allow the fiscal gap for the year through March 2017 to slip to 3.7 percent of gross domestic product from the 3.5 percent pledged earlier, Sahay said, driven by the need for continued public spending amid tepid private investment.

“At such volatile times, growth is the best defense,” Sahay said.

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