India’s Budget Plan Offers Central Bank Scope to Raise Rates

Feb. 27 (Bloomberg) -- India’s pledge to enact the biggest budget-deficit reduction in 19 years may offer the central bank more scope to drain money from the economy and rein in inflation.

Finance Minister Pranab Mukherjee yesterday unveiled plans to cut the deficit to 5.5 percent of gross domestic product in the year starting April 1 from 6.9 percent the previous year. The effort, which relies on tax increases and 400 billion rupees ($9 billion) of state asset sales, is aimed at shrinking a debt burden equivalent to about 82 percent of the economy.

The commitment means Prime Minister Manmohan Singh’s government will need to tap less of the nation’s savings than anticipated, lessening the impact on private credit growth from higher interest rates. The Reserve Bank of India may start boosting its benchmark rates at or before the next policy gathering in April, according to Goldman Sachs Group Inc.

“By cutting the deficit, the finance minister has made room for monetary tightening without crowding out” lending to private businesses, said K. Ramanathan, who helps manage the equivalent of 22 billion rupees ($477 million) at ING Investment Management in Mumbai.

Stocks rose after yesterday’s budget release, with the Sensitive Index gaining 1.1 percent in Mumbai, helping pare losses since the start of the year that were spurred in part by global investor concern about sovereign debt quality. Bonds at first rallied, then closed lower on concern a rise in the tax on fuels will boost energy costs and worsen inflation.

Ratings Impact

Fitch Ratings analyst Andrew Colquhoun said “we are marginally less encouraged to go for a downgrade” in India’s sovereign debt rating after the budget proposal. Standard & Poor’s said in a statement that it may raise its rating outlook to stable should finances improve, echoing similar remarks by Moody’s Investors Services before the release.

Moody’s ranks India’s rupee-denominated debt at Ba2, two levels below investment grade, while Fitch and S&P have a BBB- rating, the lowest investment grade. That puts India below its BRIC counterparts, which include China, Russia and Brazil.

Central banks are urging governments to curb deficits after the global recession ended and after Greece’s debt downgrade hit the euro. Federal Reserve Chairman Ben S. Bernanke this week said high deficits may cause “crowding out” of investment and Bank of Japan Governor Masaaki Shirakawa last week called for a “path for fiscal consolidation.”

In India, where policy makers aim to achieve the fastest- growing economy in the world within four years, fiscal stimulus measures saw the deficit climb from 2.7 percent of GDP two years ago. The finance ministry yesterday said public debt sales will rise by 1.3 percent, less than the 2 percent median forecast in a Bloomberg News survey, to 4.57 trillion rupees in the next fiscal year.

Subbarao Warning

Governor Duvvuri Subbarao had last month warned that fiscal stimulus, worth more than 4 percent of GDP given since 2008, must be withdrawn to ensure companies have access to funds.

“With fiscal policy in train, the focus will now shift to monetary policy to remove its massively accommodative stance,” Tushar Poddar, chief economist at Mumbai-based Goldman Sachs India Securities Ltd., said in a report. He said the RBI may raise interest rates by 3 percentage points this year to slow “rising domestic demand and inflationary pressures.”

Yesterday’s budget numbers are counting on a smooth series of asset sales, wireless license auctions and increase in tax revenue as the economy expands, JPMorgan Chase & Co. analysts said in a note. Should the deficit objective be reached, there will be “space for a strong pick up in investment and credit growth.”

‘Nasty Surprises’

“If a few things go wrong, the budget will look shaky,” Mumbai-based JPMorgan analysts Jahangir Aziz and Gunjan Gulati said in the note. “The global recovery can turn up nasty surprises and create enough anxiety to keep domestic financial markets volatile.”

Policy makers are working to unwind 7.5 trillion rupees of tax and interest rate cuts to curb consumer-price inflation that’s the highest in the Asia-Pacific region, according to data compiled by Bloomberg.

While India’s inflation has been stoked mainly by shortages in food supply after last year’s worst monsoon rainfall in 37 years, officials are concerned a surfeit of cash in the economy will spur excessive demand for services and industrial goods.

Prices paid by industrial workers in India rose almost 15 percent in December from a year earlier, the most in 11 years. Industrial production grew 16.8 percent in December, the quickest pace since at least 1994, prompting the central bank to say manufacturers are nearing capacity.

Excise Tax

Mukherjee raised the excise tax on almost all products to 10 percent from 8 percent in his budget to help trim the deficit.

Indian oil retailers including Indian Oil Corp., Bharat Petroleum Corp. and Hindustan Petroleum Corp. increased gasoline prices after the levies were announced. Gasoline prices will be raised by 2.71 rupees a liter and diesel by 2.55 rupees a liter, Oil Secretary S. Sundareshan said.

Tata Motors Ltd., India’s biggest truckmaker, will pass on the higher tax to consumers and may raise prices by as much as 70,000 rupees, Managing Director Prakash Telang said. Maruti Suzuki India Ltd. raised prices of various models by as much as 13,000 rupees with immediate effect, the company said in a statement on Feb. 26.

Bharatiya Janata Party’s Sushma Swaraj, the main opposition leader in the lower house of parliament called the budget “inflationary” after higher taxes were imposed. Swaraj led a walk-out by her party during Mukherjee’s budget presentation.

“Any kind of subsidy cut will require a trade-off between living with slightly higher inflation in the near term but with more sustainable growth dynamics over a medium term,” said Rajeev Malik, a Singapore-based regional economist at Macquarie Group Ltd. “I don’t think the move to tax fuel will mean a more aggressive tightening by the central bank.”

Usha Thorat, a deputy governor at the central bank, told reporters in Mumbai yesterday that “the budget is positive for inflation reduction, in the sense it is in sync with the expectation that we outlined.”