With election result approaching and the exit polls unanimously pointing towards a single largest party forming the government with ease; there is a wave of optimism among the investors; Nifty is trading at an all time high and INR touched an eight month peak. Everyone seems certain that there will be an immediate turn around in the state of the economy once the new government is formed. However we have also analyzed a scenario where the NDA government does not get the majority.
We have divided the report in two parts:
- If Modi Government wins with majority, which are the areas he needs to focus on and what are the challenges he may be facing.
- If the incumbent Government wins back or we have a government with weaker mandate, what would be the impact on economy.
1. If Modi Government comes with a clear majority:
Post forming the government, Mr. Modi needs to address a whole host of issues to take back the economy in the growth path and that would obviously take some time.
- Steps towards Strong Fiscal Consolidation
The new Government will need to strongly focus on the fiscal consolidation from the beginning. The Finance Ministry, headed by Mr. Chidambaram, cut government spending by $13bn and pushed back subsidy burden of about $16bn to reach an impractical fiscal deficit target of 4.6% in FY14. This austerity measures put Indian economic growth in the back burner and it is struggling to revive. The new government needs to take strong and constructive action to put back the economy on the growth path and that would not be easy when our tax-to-GDP ratio has slipped to 10.2% from a peak of 12.5% in 2007-08. First of all, a realistic and fiscally prudent budget is critical to reduce the possibility of further rating downgrades in the “Junk“category by the global rating agencies. Transparency in the public distribution system also needs to bring in to reduce the leakages and thereby better utilization of government finances. Another way to reduce the de ficit is by initiating strategic sales of state owned enterprises which will not only increase revenue but also increase the efficiency of these enterprises.
- Steps towards boosting Export and reduce CAD sustainably
The recent sharp contraction of CAD of 2.2% of GDP from the record high levels 4.8% in the previous fiscal was mainly supported by contraction of gold import due to increase in import duty. Gold smuggling is also suspected to have surged after the measures and that creates doubt on the reported data itself. This type of measures is not sustainable in long term and fixing the structural challenges is important. The new government should focus on the export of manufacturing products where India has credible opportunity, but, still not nourished properly. This can be done by building high quality ports with good connectivity, providing tax benefits to exporters, increasing efficiency and transparency in the Special Economic Zones and creating a clear land acquisition policy.
- Steps towards reviving the private investment cycle
In FY14, new projects declared by the private firms were Rs.1244bn and was sharply down as compared to the past financial years. Based on Mr. Modi’s past track record, investors are highly hopeful about new pro investment Government’s policies. In its manifesto, the BJP promised to cut red tape and encourage foreign investment in sectors needed for job and asset creation. The new government should primarily take steps in line to improve governance, instill confidence in the government machinery and streamline function across different ministries to feed the positive mood. The government should also kick start infrastructure spending to boost private investments.
- Steps towards reducing supply side bottle neck
Consistently high and sticky inflation is a major concern for India and is eroding the purchasing power. The measures taken by the RBI have to be supported by the center. The government should implement the changes in the APMC act, to allow farmers to directly sell in the markets. Refining procurement procedures to reduce hoarding & black-marketing is of utmost important as it will help reduce soaring food inflation. Changes in the NEREGA scheme to link wages to asset creation & checking the MSP prices will help curb rural inflation.
- Steps towards continuing the reform agenda
A lot of steps taken by the previous government have provided a base for reforms. The incoming government should implement and build on these as soon as possible. Passing the GST, implementing the Adhaar system for public distribution & continuing speedy clearances by CCI will further stabilize the economy and position it for a robust recovery.
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2. If a Government does not come with clear majority:
If a clear majority, stable government does not come to power, the first impact will be on seen on sentiments. Since the markets have factored in a strong NDA coming to power, a major correction will occur in the equity markets.
On the economic front, we will see some adverse impacts as well.
- We will witness a policy logjam and it will be very difficult for the incoming government to take any major decisive steps.
- Initiating the strategic sales of public owned enterprises will be an issue as it will face a lot of opposition in the parliament.
- Populous measures will continue & probably increase. This will further increase the subsidy burden.
- Large number of regional parties being a part of the same government will further deteriorate the fiscal situation as several parties will want fiscal packages for their own state and people.
- A lot of positive steps that were taken by the previous government, like the Diesel price hikes, introduction of the GST, increase in FDI limits may come to a standstill or worse, be rolled back.
- There will be some amount of political instability which will discourage foreign investors from investing in India. Lack of confidence in the economy will lead to major FII outflows and cause the rupee to depreciate.
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