Challenges the new Indian government would face

Special to Times of Oman

The current Indian elections inevitably have generated an enormous interest among the world audience and naturally, there are self-styled commentators who have sprung by a legion giving their "expert comments" on various aspects. Given the unwanted press that UPA II managed to get during the last one year on several issues, it is becoming a foregone conclusion that they will either not form the government, or if they were to return, then perhaps with a highly fractured coalition. My attempt here is not to comment on a prospective political alignment that will rule India from May 2014; rather dwell on the myriads of challenges that the new government would face.

The biggest acid test for the new government will be to present the budget in June, with a credible plan to contain the fiscal deficit.  It is not going to be easy since, macroeconomics is nothing to crow about and if any party forms the government with a fractured coalition then, politics of such arrangement will dictate all policies and all pragmatism and caution will naturally be thrown to the wind.

The finances of the Government are indeed in dire straits.  To achieve a revised fiscal deficit target of 4.6 per cent of gross domestic product (GDP) for the year ended in March, the Congress-led government cut spending by $13 billion and pushed about $16 billion in subsidy costs into the new year.

The electoral politics play a decisive role in deferring the issue of subsidies, which is indeed a holy cow.  How long can one defer payments to state-run companies that would compensate them for selling fuel, fertiliser and food at below market prices to a select group?  This has created havoc with the finances and is now making them rely on borrowings to fund operations. The government's tax-to-GDP ratio has slipped to 10.2 per cent from a peak of 12.5 per cent in 2007/08. In reality, the ideal ratio should be in the region of 15 per cent as evident by looking at statistics of many countries released by Heritage foundation during 2012.  This number would then help to contain the gargantuan fiscal deficit. But, reaching that number is not going to be easy.

Finance ministers in the past six years have sold an ever-growing amount of debt to bond investors, a solution unlikely to please markets as it pushes liabilities to the future with no resources to pay them back in a definitive time frame.

A realistic and fiscally prudent budget will therefore be essential to ensure that country's debt rating is not downgraded from "BBB-minus" to "junk" since it will have disastrous consequences.

Current account deficit is equally worrisome. The outgoing finance minister claims that both fiscal deficit and current account deficit are under control but, these are viewed very narrowly from last quarter's results. Higher duties and other restrictions almost halved gold imports but the moves have been deeply unpopular with Indian households who invest in the yellow metal to protect their savings from inflation and to provide gifts at weddings and on other special occasions.  

Gold smuggling is also suspected to have surged after the measures, casting doubt on the reported data of the Government While, it may be populist to rid gold import duty altogether which may please investors yet, more decisive efforts are needed in the area of spurring the sluggish performance on manufacturing exports. Decisive steps in a time bound fashion are essential. Weather impacted due to El Nino could play a spoil sport to government's plans.  A weak rainfall can affect the agricultural sector in a far reaching manner. Citigroup estimates that below average rainfall during June-September could shave off 0.50-0.90 percentage points in its economic growth forecast and lead to a spike in consumer inflation.  

Surging inflation could also spark tension with a Reserve Bank of India which has containing inflation a priority.  The fiscal and monetary policy could see a major tussle.  The Reserve Bank of India (RBI) wants to bring down annual consumer price inflation to around 6 per cent from the current 8.1 per cent by January 2016, which would likely mean more interest rate increases, certainly not a bright prospect.

Spurring the dormant investment cycle is sure to pose a serious challenge to the new government. We can see a major state and centre tussle emerging since most investments are states centric and the centre does not have much leeway.

According to Credit Suisse estimates only one-fourth of pending projects depend on central government approval. Capital investment contributes nearly 35 per cent to India's economy, but it barely grew in the fiscal year that ended in March as delays in clearances and funding issues grounded many infrastructure projects.

Short of recapitalising state utilities, the central government has few choices in pushing for a restructuring. Coal supply is also a key constraint, in large part due to the financial difficulties at state power generators.  Some decisive steps are needed in disinvestment of public sector companies.  Two notable candidates are Coal India and Air India.  The new government should garner enough political will to do this. Otherwise, all initiatives will be lost due to time delays.

Another area where the new government will certainly face a tough challenge will be in making banks vibrant by fresh capital infusion. India needs to fix the piles of bad loans at the country's state-run lenders, with stressed loans amounting to 10 per cent of total loan portfolio.  

The bulk of these bad loans are related to infrastructure projects, which have made banks circumspect in lending. The interim budget set aside INR 112 billion to help the sector meet minimal capital ratios mandated by Basel III norms, but more will be needed, according to analysts, creating tough fiscal choices for a new government.  

I personally feel that either flotation of preference shares with a very nominal coupon rate and with a carrot of converting to equity share say 5 years from the date of issue, at an agreed pricing formula or pure non-voting shares.  This will ensure that enough liquidity is generated.

Another important challenge is defence spending and a matching foreign policy.  Defence spending is inversely proportional an imaginative foreign relations.  If relationships with other nations are good then, it can go to reduce outlay on defence.  Hence, it is vital to ensure that peace is safeguarded at all time.  As otherwise, all assumptions will go awry.

The author is a freelance contributor based in Muscat. All the views and opinions expressed in the article are solely those of the author and do not reflect those of Times of Oman.


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Reader Comments

Let us see how NaMo and his likely FM, Arun Jaitley bring the Country back on rails. My understanding is that instead of constructive steps, they will keep blaming the past administration at every possible opportunity. Best Luck!

Very candid analysis. I wish the new govt reads this completely for their own benefit of getting such an expert opinion for their decision making. Most importantly to ensure peace with our neibhours through effective diplomatic relations.

God save us from increased interest rates and heavy duty on gold which would have impact on an average indian saving potential.

Thanks chandru for giving such an eye opener!!

Finances are a big worry. co oalition governments have no choice but to spend on populist programmes and also on whims and fancies of small regional parties who give them support making it difficult to allot enough funds to projects to achieve worthwile results. less alloction means delay ,delay means cost overruns,means more delay.
people of India for more than a decade are voting on regional basis. making small regional parties to dicatate terms .they do not have experience at the central level making a mish mash.
the sooner the people wake up the better.