Shares plunge in India amid fears over deficit

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Shares on Indian stock markets plunged yesterday by almost 6 per cent – the biggest fall in six months – as investors digested a disappointing Budget from the re-elected administration of Manmohan Singh.

As with so many governments in the West, the Indian Finance Minister's proposals to reduce the budget deficit were found wanting. Yields on government securities spiked and bank shares were also off; the 30-share BSE Index closed 5.8 per cent lower, the sharpest correction in six months. Even by the volatile standards of the Indian markets, this was a substantial sell-off. The rupee also fell against the dollar.

Mr Singh's United Progress Party coalition, led by the Congress party that has dominated Indian politics since independence, was returned to office in May, with a larger majority and, so some hoped, a mandate to restore Indian public finances to order. However the Finance Minister, Pranab Mukherjee, announced that the fiscal deficit would this year rise to a 16-year high of 6.8 per cent of GDP, up from 6.2 per cent in 2008-09 and a previously announced target of 5.5 per cent of GDP.

Despite the shocked reaction of Indian markets, such figures are, proportionally, only about half those that the UK will be seeking to raise from the gilts markets over the next two years. As expected the government plans extra spending on infrastructure, agriculture and the poor, but the key issue relates to the budget deficit and how this will be brought under control over the longer term.

Investor sentiment had been riding high following Mr Singh's decisive election victory a couple of months ago – Indian equities had risen by 50 per cent over the first half of this year.

Investors were also reported to be annoyed that the government offered only a minimal programme for privatisation of state assets.

Nick Chamie, head of emerging markets research at RBC, said: "Without a significant pick-up in revenue, which in turn is heavily dependent on the performance of the real economy, and, or, cuts in expenditure, politically very difficult in India, the deficit will remain high. Indeed, even in the past when the economy has been growing strongly, successive governments have failed to tackle India's ballooning deficit – a factor that now puts India's credit rating in jeopardy."

Some, at least of the government's caution derives from recent election pledges of a jobs guarantee programme in rural areas and a farm loan waiver scheme. However, even with its current travails, the IMF expects the Indian economy to grow by 5.6 per cent this year.