If Indian policymakers are hoping the country's slowing economy can rebound largely the same way it did from the 2008 global financial crisis, they are dreaming.
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The reason is the government cannot wield some of the tools it could the last time the world picture was gloomy.
This time, India's strained government finances and high inflation leave little room for the strong doses of fiscal and monetary stimulus that supported consumer demand and shielded the economy three years ago.
"India does not have any fiscal headroom to provide any stimulus," said Andrew Kenningham, an economist with Capital Economics in London. "It will have to brace itself for an economic slowdown longer than the one after the 2008 financial crisis."
Economic woes are mounting. On Tuesday, the rupee hit a new all-time low after the government reported on Monday that industrial output in October fell a stunning 5.1 percent from a year earlier — the first decline in more than two years.
India still has a growth rate many countries envy, but the pace is dropping quite sharply and — unlike during the 2008 global crisis — it's hard to see how government fiscal policies can jack it up.
Before the global financial crisis, India was close to achieving 10 percent annual economic growth. When the financial tsunami hit, growth slumped to 6.8 percent and then rebounded to 8 percent and 8.5 percent as the world emerged from the crisis.
Once again, growth is under pressure. Last Friday, the government slashed its forecast for the current year to around 7.5 percent from a previous forecast of 9 percent.
Growth slipped below 7 percent in the July-September quarter and, with increasing headwinds, a sub-7 percent clip is now widely expected in the near- to medium-term.
India's economy was cushioned from the 2008 global crisis by $36 billion in fiscal stimulus made up by new spending and tax cuts.
The stimulus pushed out the 2008/09 fiscal deficit by 3.5 percentage points to 6 percent of GDP, a hit New Delhi was able to absorb thanks to years of solid economic growth that shored up tax revenue and helped reduce debt.
Today, the numbers do not look so good.
The federal government's tax-to-GDP ratio is now less than 10 percent, down from a peak of 11.9 percent in 2007/08. Public debt is 70 percent of GDP, up from 68.7 percent in 2007/08.
"Even without any fiscal stimulus, this time we are staring at a big fiscal slippage on account of higher subsidies and revenue losses. Any stimulus would put too much strain on fiscal health," Anubhuti Sahay, economist at Standard Chartered Bank in Mumbai.
This year's fiscal deficit target of 4.6 percent is expected to end up around 5.5 percent.
In the first seven months of the fiscal year, net tax revenue grew just 7.3 percent from a year earlier against a budgeted rise of about 18 percent for the full year. Expenditure during the seven months rose about 10 percent, way above the 3.4 percent rise pencilled in.
Weak Public Finances
The government also failure to withdraw all the stimulus after the 2008 crisis, adding to its burden now. Global commodity prices have not come down as much as they did in 2008, so New Delhi faces higher fuel and fertilizer subsidy bills.
The original estimate for the fuel subsidy bill for this fiscal year was 236 billion rupees ($4.4 billion), but it is already 300 billion rupees more than that figure. Fertilizer subsidies are set to top 900 billion rupees against about 500 billion rupees originally budgeted.
On top of that, a June decision to cut taxes to offset the impact of hikes in diesel, cooking gas and kerosene prices has cost the government at least 240 billion rupees.
A rising subsidy bill has compelled New Delhi to seek parliament's approval for spending 978 billion rupees extra this year.
In a country where any talk of tinkering with subsidies raises a political storm, the government feels little option but to pay the increased subsidy bill.
With total subsidies for this fiscal year projected to rise by 1 trillion rupees, the government looks poised to borrow more from the market. It has already unveiled 528 billion rupees of extra borrowing by March.
A lack of funds forced New Delhi to defer State Bank of India's demand for 200 billion rupees through a rights issue.
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If the slowdown gets sharper and persists, mustering new spending to support demand even at the cost of a bloated fiscal deficit is an option. The government could ask the central bank to directly finance its deficit — but that has a cost.
"It would be a disaster as that would only fan inflation," said A Prasanna, an economist with ICICI Securities PD in Mumbai.
Fiscal constraints put the onus of reviving economic growth mainly on the central bank, which has declined so far to cut interest rates as it battles inflation, which has stuck stubbornly above 9 percent all year.
During a nine-month period in 2008/09, the Reserve Bank of India (RBI) flooded the banking system with liquidity and cut rates by 425 basis points.
Since March 2010, the RBI has raised its main lending rate by a total of 375 basis points to quell price pressures, and has enough headroom to cut if the economic slowdown persists.
"But I don't see the RBI cutting rates before the April-June quarter," said Robert Prior-Wandesforde, an economist with Credit Suisse in Singapore. "They would wait for inflation to slow down below 7 percent."
However, volatile global commodity prices and a depreciating Indian rupee — having fallen this year more than 16 percent it is Asia's weakest currency by far — could confound such hopes. Since monetary policy works with a lag, any reversal is unlikely to have an immediate impact.
Since the slowdown in 2008/09 was precipitated by a liquidity squeeze, the RBI's easing measures were quite successful. This time India's slowdown is being felt mainly by weak investment as major infrastructure projects have been stalled by policy and regulatory uncertainty.
A loose monetary policy with investment bottlenecks could reignite inflation.
"There is no alternative to speeding up policy reforms and removing investment hurdles," said Kenningham of Capital Economics, adding that loose monetary policy "could leave India with a legacy of higher inflation."
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