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Tight fiscal space clouds India's near-term recovery as GDP logs record collapse

The Indian government faces limited fiscal space to ramp up efforts to support its coronavirus-battered economy after a record collapse in GDP in the June quarter, according to analysts.

India's economy crashed 23.9% in the three months to June, undershooting analyst forecasts and marking the country's first contraction since quarterly records began in 1997. This also marked the worst GDP slump by a major economy due to the COVID-19 pandemic, even surpassing the U.K.'s record 20.4% plunge.

Nearly all industries recorded contraction, with construction and trade plunging 50.3% and 47.0%, respectively. Agriculture, the lone segment to register growth, rose 3.4%.

The recent dismal data signals that the worst may now be over for the Indian economy, though a continued spike in COVID-19 infections and the government's tight space for fiscal moves cloud the country's recovery path, analysts said.

"GDP growth might have passed its bottom but the thriving pandemic provides little hope of a near-term recovery," said Prakash Sakpal, senior economist for Asia at ING, in an Aug. 31 note. India has the third-highest number of COVID-19 infections in the world at nearly 3.7 million, with new cases numbering in the tens of thousands each day in recent weeks, according to the latest data from Johns Hopkins University.

Tight fiscal headroom

Indian Prime Minister Narendra Modi on May 12 announced a 20 trillion rupee stimulus package, equivalent to 10% of the country's GDP, in monetary and fiscal measures to counter the economic fallout from the coronavirus pandemic. The package included additional government spending that made up barely 1.2% of GDP, Jefferies said in a Sept. 1 note to clients. And with a ballooning fiscal deficit and weak government revenues, providing further stimulus will be challenging.

The country's fiscal deficit reached 8.213 trillion rupees in the first four months of fiscal 2020-21, outpacing the projection of 7.96 trillion rupees for the entire year, according to data from the country's Controller General of Accounts. This came as restrictions related to COVID-19 dragged government revenues, with total receipts at 2.329 trillion rupees in the April to July period, down 41.7% from last year.

"Against such a backdrop, the chance of additional stimulus from the fiscal side is just next to nil," Sakpal said, adding that the Reserve Bank of India's monetary easing appears to have reached its limit based on the central bank's decision to leave the policy rate unchanged at its August meeting.

UOB economist Barnabas Gan said ramping up government spending to support fiscal measures may be limited unless the government upwardly revises its deficit target. "The fiscal deficit target is expected to be revised higher, given that India has recently increased its gross borrowing target to 12 trillion rupees, up from the budgeted 7.8 trillion rupees in May," Gan said in a Sept. 1 note.

Meanwhile, DBS economist Radhika Rao believes that there is still room for targeted fiscal measures that might include cash support, lower tax rates and higher infrastructure spending in the second half. However, she warned that "limited bullets suggest the support package is unlikely to effectively boost near-term demand."

Analysts at Jefferies agree. The government has indicated that another small stimulus package may be coming just ahead of the Indian festive season starting in October and a more meaningful one later once a vaccine is available, but such "fiscal boosters are unlikely to be game changers," they said, "especially where the center is incentivizing states to borrow less and spend less."

Monetary policy space

Ahead of the GDP release, the Reserve Bank of India unveiled a slew of measures "to ensure orderly market conditions," including additional special open market and term repurchase operations. The central bank held rates steady in August as a spike in inflation halted its monetary policy intervention, pushing it to support the economy through other channels.

Looking ahead, Nomura analysts Sonal Varma and Aurodeep Nandi expect the central bank to deliver another cumulative 50 basis points in rate cuts starting in December, based on the assumption that inflation pressures will recede.

As of Sept. 1, US$1 was equivalent to 73.00 Indian rupees.