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Business News/ Market / Stock-market-news/  First budget will be key test of Modi government: Rajiv Biswas
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First budget will be key test of Modi government: Rajiv Biswas

India's economy can bounce back to 8% by 2017 if key reforms to accelerate investment are delivered in first budget

Indian Prime Minister Narendra Modi. Photo: PTIPremium
Indian Prime Minister Narendra Modi. Photo: PTI

India’s economy can bounce back to a growth pace of 8% by 2017 if the new government led by Prime Minister Narendra Modi, in its first budget, delivers key reforms to accelerate investment, and if the Reserve Bank of India (RBI) keeps grinding down inflation, said Rajiv Biswas, Asia-Pacific chief economist at IHS Global. It will be foolish for the Rajya Sabha, where the government lacks a majority, to block reforms, said Biswas. States that defy Modi’s efforts to improve the economy are likely to be punished in their next assembly elections, he added in an interview. He is also of the view that the India stocks rally will continue as the new government will be able to deliver reforms that support the underlying improvement in the market. Edited excerpts.

What can India expect from the government led by the Bharatiya Janata Party (BJP) and Prime Minister Modi?

India is expecting that Prime Minister Modi, with the BJP having a majority in Parliament, will be able to undertake a much more dynamic transformation of the economy during his first term. Expectations are high, particularly from the business community, because they were very disappointed with the last five years of the UPA (United Progressive Alliance) government. Their main concern was the lack of reforms over the last five years and that the economy had not been moving forward. India was in an economic crisis during the middle of last year, and although this has now stabilized, the business community and the electorate as a whole, are now looking for a much more dynamic growth path for the Indian economy.

What will be the key signals international investors will be watching for?

Investors will be hoping that the new government will quickly ramp up infrastructure investment. Prime Minister (PM) Modi has a strong track record in Gujarat of undertaking dynamic infrastructure development, and investors are looking for this model being replicated across the country, as infrastructure is one of the biggest problems India faces. India has a high fiscal deficit and it has also run a very large current account deficit in recent years. One of the key signals that investors will look for is the first budget, which will be delivered in the coming months, and they will want to see how PM Modi tackles issues such as fiscal reforms.

If foreign investors see that the first budget is creating a better fiscal environment, they will be heartened and may well take a new look at India, and ramp up their plans. The key will be that Modi delivers the right business climate for foreign investors and works with them closely to get their investments flowing. One of the main problems that India has had in terms of international investment flows is that corporate tax treatment has been very ambiguous and unfriendly to foreign investors. In his campaign, Modi promised he would address this, and we should expect substantial reforms to be announced in the first budget, because he has the majority in Parliament. He may come up across obstacles in the Rajya Sabha as he pushes for reforms, but it will be quite foolish for the upper house to reject Modi’s reforms. They will be flying in the face of Indian democracy if the upper House tries to hold back the reforms push.

Will the Indian economy respond to Modinomics—to this brand of economics?

This is important because in the area of fiscal reforms, one of the issues India needs to deal with in Modi’s first year is how the goods and services tax (GST) can be implemented. This has been sidelined for some years because of difficulties in negotiations between the Centre and some states. The opposition-controlled states will make his life difficult on GST. This is an important reform and it is very crucial that this is passed in order to strengthen the revenue base of the government. He will face challenges in terms of infrastructure development, but he has the momentum and support of the electorate and that is important, because states that try to defy his efforts to improve the economy are likely to be punished in their own next elections, as they will be falling behind the successful states. This is the benefit of India’s democracy.

Can the Gujarat model be replicated nationally?

I think the heart of the success of the Gujarat model is that as chief minister, Modi was very dynamic, and he worked together with foreign and Indian investors, to... make investments happen. He attracted investors and he delivered in terms of implementing their requirements—that means very fast approval processes, rapid implementation and making available the infrastructure for these projects. What the industry required was provided with very high standards.

Gujarat is one of the few states in India with a power surplus and this has helped. One of the biggest problems India has is its power generating capacity is below demand. The Gujarat model is also about clean governance, development, raising economic standards and this is what is lacking is some of the other states. In many parts of the country, corruption levels are high. The Gujarat model can be rolled out in states where the BJP is in power. But states which fail to step up and deliver are going to face a backlash from the electorate. One of the biggest needs for India is to strengthen manufacturing investments—at the moment, India’s manufacturing segment is in a state of recession and there is no growth in industrial production. This is partly due to tight monetary policy, but it is also related to issues of approvals of foreign investment.

Foreign investors have been extremely disappointed in the last few years as India’s tax treatments of their investments have been appalling. They also cannot get approvals for their projects—there were some very large projects that were cancelled because of the lengthy delays in the approval processes. Modi can make the tax system fair for all investors and then try to accelerate inward investment. He can deliver infrastructure to make these projects efficient—for instance, one of the problems is that if you lack proper power supply from the grid, you have to set up your own power plant, which is often run on diesel fuel and so your costs of electricity are much higher than the countries you are competing with. Modi understands this very well.

Certainly land acquisition will be a big problem in terms of economic development, and at the national level, there is a lot of uncertainty and this creates a lot of problems for investors when they are trying to set up large projects. It can be damaging to projects related to manufacturing, as well as urban development in terms of infrastructure, like developing a new airport. The democratic system in India will mean that some of these issues are quite complicated, and, therefore, Modi will not find it easy despite all the momentum behind him. He can’t simply make projects happen all around the country.

So how should the Modi-led government respond to the tax cases against Vodafone, Nokia and other multinationals?

In the area of taxation of foreign firms, clearly it has been an approach that was extremely unfair and also very damaging to India. The prime minister of UK, the president of the US and leaders of some of the most important trade partners of India, had to raise this issue with the UPA government. It (retrospective tax) was a really ridiculous rule and India became the laughing stock of the world in terms of tax treatment to foreign companies. This is obviously unacceptable and the BJP fully understands that this is not the way forward, and that they need to create a much fairer system and benchmark it to what other countries are doing in Asia.

India has to compete against East Asian countries that are very successful. Right now, even Indonesia with a population of a fifth that of India, attracts more foreign investment. This is unacceptable. You can’t even compare China and India anymore because China is so far ahead in terms of GDP (gross domestic product), per capita income and certainly foreign investment. India needs to start looking at the success stories of other countries as it is competing in a very competitive and successful part of the world. It has a lot of work to do to reduce poverty, which affects 30% of its population. It has really failed its people in the last few years, and part of the problem has been its inward-looking approach, and not being competitive on the tax side, which drove away major foreign investors.

Do you see the possibility of a post-election disappointment in India? Do you also see a market correction?

Indian markets have rallied quite strongly on the anticipation of a BJP victory, and after the victory, they have continued to strengthen. There is a risk that there can be a retreat at some point if there is any disappointment, due to external factors, or if the pace of reforms is not as fast as the markets would like. Nevertheless, this government should be in a position to deliver important reforms that support the underlying improvement in the stock market, so long as the global factors are not working in the opposite direction. There are global risks—the Fed is going to be tapering still through the course of this year, it is going to be raising rates next year, and all of these could impact investments into emerging markets like India. If we assume status quo on the external front, it is possible that the Modi government could support an underlying uptrend in the stock markets for some time to come, if they continue to deliver on the economic front and growth starts to pick up as a result of that action. But we are not expecting a very rapid growth of the economy—in the medium term there is potential for support of the stock market. The key test will be first budget—if it will deliver in the key areas such as tax reforms, infrastructure spending and if it will cut back on consumption expenditure.

By when do you see growth touching 8% again?

We think that growth will recover to only about 6% next year, but once the Modi reforms start to kick in, we should see a pick-up. A crucial factor is that inflation should come down a bit. Two things are crucial to get growth back to 8% by 2017 which is possible—first, BJP delivers in its first budget on key reforms to accelerate foreign and Indian investments into the economy, and the RBI continues to grind down inflation pressures so that there is some scope of easing monetary policy. For growth to strengthen in the medium term, inflation needs to be brought down—the target for RBI, in terms of CPI (Consumer Price Index), is to bring it down to 6% in the next couple of years. That is a long way to go. But the RBI has made some progress, and it is early days still, but it is possible. I certainly think 8% growth is possible by 2017—if we see inflation dipping down to at least 7% that may be enough to start relaxing monetary policy. It is the combination of fiscal reforms, infrastructure development together with monetary policy easing that can bring India back to 8% by 2017.

What measures should the new government take to contain inflation?

The RBI has done a good job, especially since governor Raghuram Rajan took office—he is a world-class central governor and has the highest respect from global investors. It is a big asset for India to have someone of his stature and credibility in its central bank. I very much hope that a BJP government will work very cooperatively with him and that Rajan remains at the helm. He has done the right thing by keeping monetary policy on the tight side and has raised rates thrice since he came in. We have seen some adjustments in inflation in the early part of this year, and I think that the government may be still concerned that it is not sufficient. I think that inflation could be back up due to seasonal factors. One of the problems that India faces on inflation is that drivers have been external factors such as oil and food prices— these are very large part of the CPI basket—and it is very hard for the central bank to address this. These drivers won’t respond to tighter monetary policy. There are other structural issues such as infrastructure bottlenecks. India needs to invest much more in developing food storage systems, food distribution, reducing wastage of crops and also have better water storage and irrigation systems to prevent some of the volatility in food prices. Part of the job in the near term is for the central bank to continue to try and grind down inflation. But the other side of the equation is medium-term reforms, which we need to see in the upcoming budget.

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Published: 30 May 2014, 06:53 PM IST
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