In the aftermath of the global economic crisis, governments around the world have taken on controversial austerity measures to grapple with crippling deficits and mounting debt. In Europe, Spain has cut over $80 billion in government programs over the next two years, the effects of which have contracted the economy and sparked countrywide protest. In the U.S., a gridlocked Congress squabbles over $110 billion in mandatory budget cuts next year through sequestration, or an automatic trigger in reductions that some have called a "doomsday mechanism."
Protected by caps on foreign direct investment and other controls on capital inflows and outflows, India has largely been isolated from the global contagion. Yet India may not be exempt from taking austerity measures at home. Adding to India’s GDP growth slowdown, high inflation, and the current account deficit at $78.2 billion– the highest ever –two other indicators provide evidence that financial health has deteriorated.
1) Foreign exchange reserves are falling
Firstly, foreign exchange reserves are falling. These reserves, in part, are used to meet debt obligations like payments on interest and on principal. While India can easily service those obligations, fiscal health can be measured by the central bank’s ability to cover external debt with foreign exchange reserves. For the first time in nearly 10 years, it cannot cover its debt. As debt has expanded at a compound annual growth rate of 12.7% to $345.8 billion, foreign exchange reserves have fallen to $292.5 billion – a $53 billion gap.
2) Sovereign debt is higher than it’s been in seven years
Second, according to an RBI report released this June, sovereign debt is higher than it’s been in seven years, accounting to $81 billion, just under one-fourth of India’s total external debt. The debt maturity profile is evolving as well. As a percentage of total sovereign debt, debt up for maturity within one year or less has tripled from $3.5 billion in 2009 to $10.5 billion in 2012. This means that 12% of government financing expires in the next year, up from only 6% three years ago. If bonds are not repurchased, India could lose out on $10.5 billion, a sum that could eliminate funding for the entire police force or welfare schemes like MGNREGA.
To be more fiscally responsible, India will have to raise taxes or cut spending. It will likely do neither, and its path to austerity will look unlike anything seen in continental Europe or the United States.
So far, the Indian government has set a target for a 10% cut in discretionary spending. To accomplish this aim, there are a few global patterns to consider.
In the pecking order of austerity measures, defense budgets have regularly been a primary target for cuts. At the outset of its crisis, Italy cut its defense budget by 10%. In the U.S., sequestration mandates that next year at least $50 billion in cuts come from military expenditure– a direct blow to the aerospace and defense industry. This option is unlikely for India. In the background of China’s growing military power, India has become the world’s biggest importer of arms as defense spending is up 17% from last year to over $41 billion. Billionaire Mukesh Ambani’s new company, Reliance Aerospace Technologies Pvt Ltd, is another indicator for markets that sentiment towards India’s indigenous defense industry is growing.
The next target has been reductions in state or regional government budgets, which really means cuts in education and welfare. Spain’s central government has cut regional budgets by $3.5 billion. This won’t happen in India either, as states are receiving more grants from the central government for urban planning and welfare schemes. Last year, the increase amounted to over $5.7 billion. There is also a general sentiment that emboldening regional governments makes beneficiaries of grants more accountable to their budget, making cuts unlikely.
India’s austerity measures will focus instead on finding efficiencies in wasteful programs.
Besides limiting travel and hotel accommodations for officials, the government has reiterated a hiring freeze on the civil service. In the debate to cut expensive oil and gas subsidies, the government has also supported nationalizing pilot schemes that directly transfer subsidies to beneficiaries, streamlining delivery as part of the government’s Aadhaar initiative. These ‘cuts’ are not just difficult to measure because of limited accessible records on government spending, they hint at a greater problem for India.
India is caught in a geo-economic catch-22. Not only is it hesitant to expose itself to hot money by opening up foreign direct investment, it also feels obligated to fund costly welfare programs that are not just politically sensitive, but critical to sustain basic standards of living. It is often said that “Washington doesn’t have a revenue problem. Washington has a spending problem.” New Delhi has both.
Perhaps the government seldom has opportunities to cut spending, or lacks the tools to raise and save money. Maybe it’s the blurred line between mandatory and discretionary spending. Regardless, the results are artificial savings mechanisms that avoid solving real fiscal problems. In this light, India’s path to austerity represents more of an asymptote, a geometric line infinitely approaching a target it will never meet. But if history has shown anything, it’s that a crisis may straighten the course.