India's Economic Growth and Inflation Key Challenges for New Government

As the fate of India’s political parties is being decided in the world’s largest democratic electoral process, the country’s economy is poised to emerge from a period of low growth, according to Maplecroft.


On 12 and 13 May 2014, the Indian stock markets reached record highs after opinion polls revealed that the opposition National Democratic Alliance (NDA) – a coalition headed by the right-wing Bharatiya Janata Party (BJP) – was set to win an outright majority in parliament.


Expectations are running high that Narendra Modi, the NDA’s prime ministerial candidate, will rejuvenate India’s economy by replicating his record of economic growth and attracting investment in Gujarat on a wider scale. Modi is committed to liberal economics, the free flow of capital, support for foreign investment, and infrastructure development. However, India’s structural problems, including sluggish industrial growth, a high fiscal deficit and frequent spikes in inflation, will make Modi’s task difficult.


The next government will be in place no later than the first week of June. An interim budget for the rest of the financial year (until the end of March 2015) will be presented shortly thereafter. Although Modi is committed to economic reform, radical changes to policies on taxation, regulatory framework or subsidies are unlikely in the interim budget.


Return to 8%+ growth rates unlikely in the medium term
After reaching a high of 9.3% in the 2011 fiscal year, India’s GDP growth has slowed in subsequent years, owing to lower levels of investment and global demand. India’s GDP growth is widely forecast to be below 7% for the next two years.


Multiple factors have affected gross capital formation and GDP growth in recent years, the most notable of which is a decline in foreign direct investment due to loss of investor confidence. The impact of this weakening sentiment can most notably be seen in the industrial sector, which accounts for nearly 25% of India’s GDP, but has recorded low single-digit growth since 2012.


The slowdown in industrial growth is due partly to a negative growth rate in the mining industry, which has been hit by a series of scandals in the acquisition of mining licenses since 2011. The most notable of these is a US$33 billion scam in the award of coal mining licenses in 2012. While investigations are ongoing, licenses are currently on hold or have been revoked.


A Modi administration is likely to focus corruption investigations on licenses issued in states governed by its political opponent, the Indian National Congress (INC), such as Maharashtra and Andhra Pradesh.


Widening of fiscal deficit and high inflation remain problematic
Achieving the government’s own fiscal deficit target of 4.8% of GDP in FY2014 would depend partly on the participation of private investors in the disinvestment process, and the government’s ability to cut subsidies on energy and fertilisers.


In FY2014, the government could raise just INR59 billion (US$1.3 billion), against the original target of INR558 billion (US$9.25 billion). The new government will have to prioritise disinvestment on an urgent basis to avoid a potential downgrade to India’s sovereign rating.


India is rated at just above junk investment grade by major international credit rating agencies.


Inflation in India is heavily influenced by vagaries in food prices. Indian agriculture still remains predominantly dependent on the monsoons, which leads to uncertainty in supply.


In 2014, the monsoons are likely to be heavily affected by the El Nino phenomenon, which could potentially hurt food supply. As a result, tackling inflation (which stood at 8.59% in April 2014) will be a high priority for the new administration. This will mean that cuts in fuel subsidies are unlikely in the short term at least.


With all these economic challenges, the task facing the next administration is intense. Narendra Modi has a demonstrated record of good governance in Gujarat, such as providing 24-hour electricity, and improving road infrastructure. Given the strong majority that he is expected to win in the elections, Modi will have an advantage in terms of being less reliant than his predecessors on fickle political allies.


India’s growth story is unlikely to return to its peak as seen in the last decade but a Modi administration can be expected to restore investor confidence and reduce corruption risks in the medium term.

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