Graphic: Ahmed Raza Khan/Mint
Graphic: Ahmed Raza Khan/Mint

A binary outlook for India

The choice for India is between a Modi-led government that can quickly get the economy moving, and a Third Front, supported by the Congress, with hubris and populism as its common denominators

The Central Statistics Office has put out an estimate for real economic growth (real gross domestic product, or GDP, growth) for the year ending 31 March. It is 4.9%. A day earlier, the National Council of Applied Economic Research (NCAER) had released its estimate of real GDP growth. It had pegged the estimate at 4.7-4.9%. Only in November, it had revised it down to 4.8-5.3% from its earlier forecast of around 6%. Both the government and NCAER forecast 5.6% real GDP growth for 2014-15. As of now, the risk to this estimate lies on either side of it.

As important, if not more, is the government’s budget deficit. NCAER reckons that the government would miss its fiscal deficit target of 4.8% (of GDP). It projects the deficit at 5.1% of GDP. Even if the UPA government meets its fiscal deficit target for 2013-14, it will do so only at the cost of risking higher deficits in the future and weakening the finances of public sector companies. Moreover, the damage to government finances continues uninterrupted. In recent weeks, the government has raised the cap on subsidized cooking gas cylinders from 9 to 12 per connection and has also delinked the issue of subsidized cooking gas from Aadhaar whose purpose was to make delivery of subsidy more targeted and effective.

Whether intended or not, the UPA government’s policies amount to leaving a scorched earth for the new government. It is difficult for us to decide whether to fault the UPA government for its corruption or mal-governance or fiscal irresponsibility or the damage it has inflicted on other institutions of governance. Take, for example, the Reserve Bank of India. Thanks to the UPA’s fiscal policy and its inevitable monetization, the proportion of government securities that the central bank (RBI) is holding, exceeds the securities that the Federal Reserve is holding in the US as a percentage of GDP (see the accompanying chart). The UPA’s fiscal policy has so thoroughly blanketed the monetary policy of RBI, especially since the UPA returned to office.

Monetary policy is, as such, somewhat of a blunt instrument in India given the relative lack of penetration of banking and the large food component in the inflation basket. The three major charges against the UPA’s fiscal spending of the last five years (if not 10 years) are that it has been largely unproductive, it has crowded out the private sector from the banking system forcing it to go for riskier foreign loans and it has reduced monetary policy effectiveness so thoroughly as to burden the aam aadmi (common man) with a relentless rise in his cost of living. The financial savings of Indian households has declined five percentage points in the last four years, further aggravating the resource crunch in the banking system. One could not have come up with a better policy concoction to eviscerate the economy.

Perhaps, there is a silver lining to all this. Some have been arguing that the prolonged spell of weakness in India’s capital goods production and in gross fixed capital formation is a good thing for it signals balance sheet restructuring in the corporate sector. There has been some anecdotal evidence of that too although data is not readily available as to the extent to which deleveraging has taken place among Indian corporations. However, the deceleration in bank credit growth indeed points to balance sheet repair. Moreover, external commercial borrowings are not so easily available to Indian corporations after they gorged on it up to 2012. That is a good thing too.

The slow consumption of credit by the private sector coupled with the recent rise in the real prime lending rate should allow the non-food inflation rate to decline. A good monsoon will help by keeping food prices in check. Then, the overall inflation rate too might finally begin to decline in India giving RBI room to cut interest rates in the second half of fiscal 2014-15.

Thus, in the second half of this year, the outlook for the Indian economy, the currency and the stock market looks increasingly binary. A stable and decisive National Democratic Alliance government, post-elections, led by Narendra Modi can quickly get the economy moving. Incrementally, some investment activity will revive quickly. In that case, the growth rate of 5.6% for 2014-15 might be eminently achievable. Also, the Indian stock market will perform better than many of its emerging market peers. In fact, should the Chinese economy crater, India might be the emerging market safe-haven in the second half. If anything, animal spirits might revive so wildly that RBI might have to deploy its macroprudential tools to prevent a quick reheating of the Indian economy.

On the contrary, a Third Front government, supported by the Congress, with hubris and populism as its common denominators, will almost surely result in an economic crisis with the rupee plunging and funds leaving the stock market. India’s credit rating will be downgraded, so will India’s economic growth forecasts. The choice for investors, entrepreneurs, economists and financial pundits in the coming elections cannot be clearer.

V. Anantha Nageswaran is the co-founder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at baretalk@livemint.com. To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk-

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