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India Moves to Revive ‘Animal Spirit’ in Its Economy

After promising for months now a plan to turnaround India’s troubled economy, Prime Minister Manmohan Singh finally delivered on Thursday what’s widely viewed as the boldest measure yet — in the form of a controversial fuel price hike.

Bombay Traffic
Neil Beer | Photodisc | Getty Images
Bombay Traffic

The move, which will increase the price of heavily subsidized diesel by 14 percent for the first time in 15 months, is part of Singh’s widely-touted push to revive the so-called “animal spirit” of the economy, and to stave off the looming threat of a credit rating downgrade.

India’s coalition government has been accused of being in the grip of a policy jam that’s prevented authorities from delivering unpopular fiscal reforms to curb the country’s ballooning deficit. Ratings agency Standard & Poor’s warned earlier this year that India could be the first country among the BRIC nations (Brazil, Russia China) to lose its investment grade.

Therefore the news of the cut in fuel subsidies sparked a rally in Indian stocks — which jumped more than 2 percent on Friday — and is equally cheered by India watchers, who say this is the start of more positive news to follow.

“This step by the Indian government seems to be part of a package to improve fiscal efficiency and revive ‘animal spirit’ in the economy. We expect to see further measures to liberalize the investment environment,” Taimur Baig, Chief Economist at Deutsche Bank, told CNBC.

Ridham Desai, Managing Director at Morgan Stanley Research, said the hike in diesel prices is a “fairly big step” for a government that has not done anything significant for so long. He added that if it is followed by announcements allowing foreign direct investment in some sectors it could stop the economy from going into a “downward tailspin.”

There have been media reports that the Indian government is looking to open up the aviation sector to investment from foreign airlines plus divesting its stake in some public sector companies. This suggests the government is finally waking up from a policy paralysis that has been the cause of much of India’s ills from slowing growth to a depreciating currency .

Raising fuel prices is deeply unpopular and politically sensitive because of its impact on the cost of living. The latest wholesale price index, the key gauge of consumer prices came in at a higher-than-expected 7.55 percent in August, showing inflation remains a problem for the economy.

But fuel subsidies have been a big drain on India’s finances and there has been a growing call for India to cut government expenditure.

According to Robert Prior-Wandesforde, Director Asia Economics at Credit Suisse, this move is symbolic as it shows the Singh government’s resolve.

“I think this (fuel hike) is symbolically quite important. Though it will not have a huge impact on the subsidy bill, investors will react positively as they had given up hope of reforms from this government,” he said.

Baig estimates the hike in diesel prices will reduce the fiscal deficit by a quarter percent of gross domestic product. While this may not be enough for the government to reduce its deficit from 5.8 percent of GDP to the targeted 5.1 percent by the end of the current fiscal year in March 2013, it will still lessen the risk of fiscal slippage. “It will at least prevent it from going to 6 percent,” said Baig.

But as the mood turns optimistic and the rhetoric becomes positive, Prior-Wandesforde warns against getting too carried away. “India has to follow up this move with other investor friendly measures, otherwise we are set up for disappointment,” he said.

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