INDIA MANAGING IMPACT OF GLOBAL FINANCIAL CRISIS ALTHOUGH

UNCLAS SECTION 01 OF 03 NEW DELHI 000103

SIPDIS
SENSITIVE

STATE FOR SCA/INS AND EEB
USDOC FOR ITA/MAC/OSA/LDROKER/ASTERN/KRUDD
DEPT PASS TO USTR MDELANEY/CLILIENFELD/AADLER
DEPT PASS TO TREASURY FOR OFFICE OF SOUTH ASIA MNUGENT
TREASURY PASS TO FRB SAN FRANCISCO/TERESA CURRAN

E.O. 12958: N/A
TAGS: EAGR ECON EFIN EINV ETRD IN

SUBJECT: INDIA MANAGING IMPACT OF GLOBAL FINANCIAL CRISIS ALTHOUGH
DISTRACTED BY ELECTIONS AND REGIONAL TENSIONS

REF A) SECSTATE 00134459 B) 08 NEW DELHI 002995 C) NEW DELHI 00022
D) 08 NEW DELHI 00003177 E) 08 NEW DELHI 3143 F) NEW DELHI 000044


1. (SBU) Summary. Per Ref A, Mission provides an update on how
India is weathering the global financial crisis and subsequent
economic slowdown and on the political economy of the impact and
government response. India's economy, already slowing from lower
domestic spending in a high interest regime, has also been hit since
October by decreased global demand for its textiles and jewelry, as
well as seeing private and public investment in infrastructure and
capacity expansion stymied by frozen credit markets (ref B). Two
stimulus packages were dominated by relatively aggressive monetary
loosening and foreign financing liberalization, along with some
targeted fiscal support. Most economists still expect the Indian
economy to expand between 6-7% in the current fiscal year, ending
March, and then to fall to a 5-6% growth band for the rest of 2009.
National elections by May and tensions with Pakistan may limit Prime
Minister Singh and his economic team from contributing more to G-20
efforts than these domestic responses. End summary.

FISCAL STIMULUS PACKAGES
--------------


2. (SBU) The Government of India and the central bank, the Reserve
Bank of India (RBI),have created two stimulus packages in the last
month (ref C and D). Since big populist programs this year already
limited the government's capacity to spend, the fiscal stimuli were
very modest, mainly targeting the hard hit sectors of
infrastructure, real estate, and SMEs, which are labor-intensive.
CRISIL's principal economist, DK Joshi, and IMF resident
representative, Sanjaya Panth, both think there is little left the
government can do on the fiscal side because of spending
constraints. Indeed, when the government announced the January 2
package, it noted its intention that this would be the last fiscal
package of the year, although a fuel price reduction is rumored.


3. (SBU) Monetary policy has notably loosened since September, and
the two stimulus packages cumulatively brought the main policy
lending rate down by 100 basis points to 5.5%, while the reverse
repo rate, the rate at which the RBI pays banks for parking their
funds with it, has been brought down to 4% to deter banks'
preference to keep funds safe with the central bank rather than
lend. These moves, along with reductions in the cash reserve ratio
(CRR) and government pressure on public sector banks, have prompted
a few banks to lower their deposit and lending rates, although the
prime lending rate has barely moved. Vaishali Nigam Sinha, Senior
Vice President, Macquarie Capital Advisers, thinks the first
stimulus package has eased borrowing for some companies, especially
in the infrastructure and real estate sectors. In addition, bankers
in Mumbai think that trade finance has eased recently. However, RBI
data shows banks are still parking significant funds with the
central bank, suggesting that liquidity has eased but banks are
still hesitant to lend. Meanwhile, regional economic differences
limit the usefulness of looser monetary policy. Our Consulate in
Kolkata noted that commodity-consuming industries in resource-rich
eastern India are struggling with lower commodity prices and higher
inventory and are not in need of working capital.

FINANCIAL REFORMS SLOWLY SOLDIER ON
--------------


4. (SBU) Commendably, the regulators have continued with planned,
albeit incremental, financial liberalization while the government
has introduced newer measures to encourage capital inflows. In
response to a net outflow of portfolio investment, the stock market
regulator, SEBI, removed the ban on participatory notes, a form of
derivative portfolio investment. The Ministry of Finance also
loosened the restrictions on external commercial borrowings and
raised the cap on foreign portfolio investment in the corporate debt
market. Finally, RBI continued with its rollout of futures
derivatives last fall and is on track to launch interest rate
derivatives this month.

ECONOMIC OUTLOOK: STILL MIXED, LESS DIRE
--------------


5. (SBU) Since steep contractions were noted in October export and
production data (ref B),recently released November production and

NEW DELHI 00000103 002 OF 003


infrastructure data shows a return to positive territory, although
still off from strong showings last year at the same time. The
index of industrial production (IIP) rose 2.2% in November compared
to 4.9% growth in November 2007; April-November growth was 3.6%
compared to 6.4% during the same period in 2007. Preliminary
estimates of exports in December were still off, but only down by
1%, compared to the October year-on-year plummet of 12%. Meanwhile,
some major Indian steel companies noted this week that domestic
demand seems to be picking up and they are planning to return to
full production after having cut back in late 2008.


6. (SBU) Some sectors of the Indian economy continue to hurt,
especially textile and gems and jewelry exports and auto component
domestic and export sales (ref F). The Ministry of Commerce has
revised downwards its export target for the fiscal year from $200
billion to $175-180 billion. Total exports last fiscal year were
$162 billion; exports from April to December were $130 billion,
representing the 30% growth exports experienced in April to August.
The stimulus packages had some targeted concessions for these
groups, but industry representatives say they are not enough.


7. (SBU) Although the balance of payments turned negative in the
April to September quarter (latest available data),foreign exchange
reserves, at $250 billion, remain sufficient to cover 2.5 times
short term debt. Since much of the April-September trade deficit
was due to the peak oil prices over the summer, analysts expect the
import bill to fall in the coming months, although declining exports
mitigate the improvement. Anecdotally, foreign worker remittances
remained strong through December, especially through
government-sponsored Non-Resident Indian (NRI deposits),whose
deposit rates were raised to attract such funds. India leads the
world in remittances, last year earning roughly $40 billion.
Foreign exchange reserves have not fallen in recent weeks and the
rupee has remained in the 48-49 range. This suggests that capital
flows may have stabilized compared to the $60 billion loss in
reserves last year as the RBI intervened in forex markets to
mitigate the rupee's roughly 20% depreciation from September to
December.

BILATERAL TIES NOT HARMED
--------------


8. (SBU) Post has not seen any signs of negative fallout from the
financial crisis on bilateral relations. Indeed, when Post
delivered the recent G-20 demarche to the Ministry of Commerce and
Industry (ref E) on how the government's November increase in
several import tariffs went against the G-20 Communique, the
Ministry's response was mild and rather technical in nature.
Government officials have not spoken critically of any US domestic
policy moves, and in recent months, have not framed the global
economic slowdown as the US' fault. The government has not
instituted any additional tariff increases since the raising of
several import duties in November, although it remains under
pressure from industry to do so.

ELECTIONS LOOMING; GOVERNMENT DISTRACTED
--------------


9. (SBU) While the GOI has crafted two stimulus packages, domestic
politics are strongly dominating government bandwidth these days.
The two main events are approaching national parliamentary
elections, which must take place no later than the April-May
timeframe, and ongoing tensions with Pakistan in the wake of the
November Mumbai attacks. The government was probably motivated to
move quickly on the stimulus packages, a key recommendation of the
G-20 summit, because mitigating the economic slowdown is in the
ruling coalition's interest as it prepares for elections. However,
active G-20 participation by India in the next few months may be
constrained by election preparation. In addition, the government is
preoccupied with a "coercive diplomacy" effort to pressure other
governments to apply harder pressure on the Pakistani government to
move against the perpetrators of the Mumbai attacks.


10. (SBU) India's apparent attempt to pursue non-military responses
could lead it to seek punitive economic steps against Pakistan,
which would go against the spirit of the G-20 Communique supporting
united efforts towards world growth. Home Minister Chidambaram was
quoted in the London Times this week (and widely re-quoted) as

NEW DELHI 00000103 003 OF 003


threatening to sever trade and civil ties with Pakistan if it did
not take adequate steps to help find those responsible for Mumbai.
Meanwhile, Chidambaram's move to the Home Ministry in December has
left the Finance Minister's position empty. Contacts have told
Econoffs that Planning Commission Deputy Chairman Montek Singh
Ahluwalia is informally filling the role in conjunction with Prime
Minister (and a former Finance Minister) Singh. While they are both
highly capable economic managers, the elections and regional
tensions leave less room for the Prime Minister to dedicate to
global issues.

COMMENT
--------------


11. (SBU) India's top economic leadership has so far rather deftly
handled the impact on India of the global financial and economic
downturn. But looming elections and regional tensions, combined
with double-hatted economic management, could constrain India's
ruling coalition from active leadership in the G-20 process in the
coming months. However, these distractions may not matter much to
India's economic performance during the next six months as several
economists tell Econoffs that there is little left the government
can do to mitigate the crisis. While forecasts on India's growth
diverged significantly late last year, there is growing consensus on
India's growth projections for the coming year as its trajectory
becomes clearer. India's exports will have to ride out the global
slowdown, but the country's domestic demand appears resilient enough
to maintain growth in the 5-6% range through the worst of the global
downturn and keep India as one of the fastest growing economies.

WHITE