The Indian cabinet yesterday approved an average 21 per cent pay rise for 5m federal employees and military personnel. This is effectively the first revision of government salary scales for 12 years. P. Chidambaram, finance minister, said on Thursday that the civil servants’ pay rise, to be backdated to January 1 2006, would cost Indian taxpayers $3.6bn (€2.4bn, £1.9bn) this fiscal year, including part of the arrears from 2006. Separately, Indian Railways will have to pay $1.5bn to its employees.
Basically the problem here would seem to be the timing of this decision. The majority of the civil servants in question here are hardly going to be well paid, although many of them may well be doing tasks of questionable value, either economically or socially. However this decision is likely to complicate the inflation battle significantly, and raises the level of concern on the fiscal deficit front.
The real issues here are associated with the burden represented by subsidies for fuel and other necessities, which are now estimated to exceed 5 per cent of gross domestic product. The pay rises, by way of comparison, are estimated to represent a costof 0.4 - 0.5 per cent of GDP. India's Finance Minister Palaniappan Chidambaram has said the salary rise had been factored into the government budget for the current fiscal year and will not affect the budget deficit target of 2.5 per cent of GDP, but the issue is really that the subsidies are effectively not included in this calculation, since they are off balance sheet. Indeed, only yesterday the prime minister’s Economic Advisory Council warned that the government’s fiscal situation “no longer looks stable or sustainable” as a result of the growing subsidy bill.
The Reserve Bank of India last month raised its benchmark rate by a half point to a seven-year high of 9 percent. The reserve requirement for commercial lenders was also lifted to 9 percent from 8.75 percent. Governor Yaga Venugopal Reddy, who is targeting inflation of 7 percent in the year to March, has said he is ready to act again if necessary, and it now seems almost certain that he will need to.
Foreign Exchange Reserves
India's foreign exchange reserves fell by US$ 5.464 billion to US$ 300.010 billion during the week ended August 8 from US$ 305.474 billion during the previous week. The country thus registered a fall in its foreign reserves for the fourth consecutive week. One part of the explanation for this weeks rather large drop may well be that the Reserve Bank of India has been selling dollars to keep a cap on the value of the rupee.
So, after some years of buying dollars in the forex markets, the RBI has now started selling dollars. Strong portfolio inflows continue, and the central bank continues to mop up what it perceives to be excess liquidity coming from this quarter. However oil importer demand for dollars has been up sharply in recent weeks forcing the central bank to be net sellers of the dollar. As result, total reserve with the central bank has dipped almost $10 billion since the beginning of this fiscal year in April. Nonethless a 5.5 billion USD drop in one week is quite sharp.
Despite tighter monetary policy from the RBI the supply of credit continues to expand, and grew by 25.8 per cent during the year up to August 1, 2008, compared with 23.3 per cent growth registered a year earlier. Outstanding bank credit stood at Rs 24,27,592 crore on 1 August. Banks have extended credit worth Rs 65,678 crore since April 2008. Advances declined by Rs 1,787 crore in April-July 2007. The central bank has projected a 20 per cent growth for adjusted non-food credit in 2008-09.
Deposit expansion on the other hand has failed to keep pace, and deposits only grew by 20.9 per cent in the year to 1 August 2008 against a 24.4 per cent rise in the same period last year.
On the other hand the drop in foreign exchange reserves does seem to be having an impact on the rate of growth in the money supply (since of course dollar sales mean less rupees going the rounds), and money supply growth has dropped back, for the first time this fiscal year, to within the banks comfort zone of below 20%. As per the latest RBI data, the Y-o-Y growth in money supply slipped to 19.6% as on August 1, from a high of close to 23% a few months ago. The total stock of money in the system amounted to Rs 41,79, 900 crore as on August 1, up Rs 32,479 crore over the previous fortnight’s levels.
Rupee
India's rupee declined on Thursday by the most in three months on speculation global stock losses will spur investors to pare riskier emerging-market assets. A 27 percent drop in India's benchmark stock index has prompted global funds to exit the market as it heads for the first annual loss since 2001. The rupee fell 1 percent to 43.055 per dollar at the 5 p.m. close, the lowest since July 16
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