India’s retired military men keep interest rates higher in Asia’s third-largest economy?

Will a new multi-billion dollar bill to take care of India’s retired military men keep interest rates higher in Asia’s third-largest economy?

Since New Delhi agreed over the weekend to demands from members of the military for a more generous pension scheme, analysts have aired doubts about the ability of the government to stick to its fiscal plans.

Any concern that the government is unable to stick to its fiscal targets could delay a lowering of interest rates and even a stronger economic recovery, analysts say, because it could convince Reserve Bank of India Governor Raghuram Rajan to put off any further easing.

Mr. Rajan is keeping New Delhi on a tight leash: he has said time and again that a healthy budget is a pre-condition to a more accommodative policy.

The government has in principle accepted what India has been calling the “One Rank One Pension” plan, a demand by defense personnel that the same pension should be paid to armed force retirees with the same rank and the same length of service, regardless of the year they retired.

The move is likely to add significantly on the fiscal bill: economists at HSBC estimate it will cost the country 160 billion rupees, or around $2.5 billion, in the year ending next March alone.

Unfortunately that’s not the only unexpected cost in the country’s books this year. Last month, the finance ministry announced it would be spending 170 billion rupees to recapitalize capital-starved public sector banks. Meanwhile the recent stock market weakness in India and around the world has made it unlikely India will be able to raise the revenues it had planned to pocket by selling stakes in government companies. That could leave another 340 billion rupee shortfall, HSBC estimates.

“All of this means that the path of fiscal consolidation has become harder,” HSBC chief India economist Pranjul Bhandari said in a note Monday.

Some positive factors – including a fall in India’s fuel and fertilizer subsidy bill on the back of falling commodity prices, expenditure reductions and a higher-than-expected dividend from the central bank – will help relieve the pressure for now. But the outlook for next year is less encouraging, economists warn.

India should be able to meet its target of keeping its fiscal deficit at 3.9% of gross domestic product this fiscal year. However if it wants to continue lowering that deficit as planned to 3.5% next year and 3.0% the year, India will need to cut costs and find new sources of revenues, said Nomura in a report Monday.

“Continued fiscal consolidation beyond FY16 will require structurally addressing both the expenditure (deregulating the remaining fuel and fertilizer prices) and revenue side (broaden the tax base) of the fiscal balance,” Nomura said.

Mr. Rajan will be watching closely.  He cut rates three times since the start of the year to the current level of 7.25%, the lowest level India has seen since May 2013.

In a recent interview with the Wall Street Journal he said that the RBI is still in “accommodative mode,” but he quickly added that the bank’s policy will be driven by upcoming news.

“We’re looking at the data to see what more room we have,” he said.


http://blogs.wsj.com/indiarealtime/2015/09/07/will-indias-new-military-pension-bill-derail-its-deficit-plans/