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Challenges for Modi government

LiveMint logoLiveMint 21-05-2014 Rajesh Kumar

Indian voters have given a verdict that few could have predicted. While political pundits and analysts will slice and dice the election result data in several ways in the days and weeks to come and reach their own conclusions, the bottom line is that this election was about Narendra Modi, now the Prime Minister (PM)-elect.

Since the campaign and the verdict were unprecedented in more ways than one, expectations are also running sky high. From common households to most sophisticated investors in the financial markets, everyone is expecting things to change for the better. Further, if the election campaign and the verdict is anything to go by, every decision that the new government takes will be analysed and scrutinized like never before, as was done by economists, op-ed writers and intelligentsia in general with Modi’s track record as chief minister of Gujarat. It is likely that commentators will not be willing to give the incoming government any margin for error whatsoever.

There are several areas that will need the new government’s immediate attention, but this column will restrict itself to the state of the economy and the expectations in the financial markets. It was not long back that people in the financial markets used to talk about India and China in the same breath. But that is no longer the case. Although the economic growth in China has also slowed, we have lost the momentum, completely. Yes, the global economic conditions have been difficult in recent years, but that does not fully explain the deceleration in the economic activity in India. The Indian economy in the present global environment needs more pro-active management.

One of the biggest advantages that India has with its growing working age population is that unlike the developed world, it is not a demand-constrained economy. It is a supply-constrained economy, and the persistently high level of inflation over the years underlines this fact. Therefore, the government will have to work towards clearing supply-side bottlenecks. This itself will be a huge task and would involve working in various areas and with multiple actors, including state governments.

Continuing with inflation, rising food prices have been a serious issue. The problem has been magnified because the government over the years has undermined the role of markets in food economy. As a result, we have excess stock in one kind of product and shortage in others.

The other big problem that the Modi government is likely to face is our inability to create capacities to take advantage of opportunities, both in the domestic and global scenario. India is ranked 134th among 189 countries in Ease of Doing Business rankings by International Finance Corp. The business and investment community is hopeful that conditions will improve from here on. Better rankings in Ease of Doing Business would indicate an overall improvement in the business environment.

Furthermore, in one of the speeches made in the capital during the campaign, Modi had said that before introducing a new law, the government should also think about repealing outdated laws. If the idea is taken forward, it is likely to help businesses.

Management of government finances will again be a big challenge. The outgoing government had run a higher level of deficit for far too long, which is one of the big reasons why the economy is in the state that it is. Therefore, it is important to contain expenditure, especially on subsidies and quickly bring it down to sustainable levels. The election outcome itself signifies that people of India are not necessarily looking for dole-outs. The aspiring India that has voted for Modi government is looking for opportunities, which can be created at a faster pace if part of the consumption expenditure is directed towards asset creation. It has been articulated by the PM-elect on several occasions that the government will work for the poor. There cannot be a disagreement on the objective, but the critical part is the ways and means to do so. The options are either to continue with the subsidy approach or use resources to build bridges that will bring the poor into the mainstream.

In the context of Union budget, it will also be important for the government to present numbers in a transparent manner with a credible plan of fiscal consolidation. The sense is that the financial markets will appreciate this approach even if the deficit goes up in the current year. It will also help if we have a clear roadmap for implementation of the Goods and Services Tax and the Direct Tax Code.

Financial markets will also be interested in the new government’s approach towards state-run companies. Public sector banks are struggling with non-performing assets and need capital infusion, but the government has limited resources. Unless the banks are well capitalized, they will not be in a position to lend, affecting growth prospects. This could be a good opportunity to allow banks to compete for capital in the market on their own.

In a globalized environment where economies and financial markets are interlinked and interdependent, communication has an important role. This was a big problem area for the outgoing government. It is a standard practice for top management of large listed companies to answer analysts’ questions every quarter. The Reserve Bank of India, too, interacts with the media and analysts after reviewing policy. It would be encouraging to see the top leadership of the government follow such a practice, maybe in different state capitals.

End note: High expectations is a double-edged sword. It can keep the government on toes or quickly lead to dissatisfaction. India has lived with discontent for a while; it’s time for action.

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