Will the Modi Budget jump start India’s economy?

Arun Jaitley, India's Finance Minister, presented the Modi government's first budget in July. In his speech, he outlined his road map for the economy, which included measures to improve infrastructure, reform the tax system and allow more foreign investment in the defence and insurance sectors.

However, he steered away from announcing any large-scale changes to the economy. This budget, he said, was only the beginning of a journey towards achieving a target 7%-8% rate of GDP growth within the next 3-4 years.

State of the economy: low growth, high inflation

The new government, which came to power following a landslide victory in the elections held in May, inherited a slowing economy afflicted by high inflation. Specifically, in 2013, GDP grew by 4.7% while the inflation rate (for wholesale prices) was around 6%.

The Annual Economic Survey (AES), which was released by the government a day before the budget, presented a mixed but improving picture. Specifically, according to the AES, the economy was projected to expand by around 5.4%-5.9% in the 2014-15 fiscal year (FY), which is a small improvement over previous years and similar to our projections.

While we think the GDP growth target for this year is achievable, this is a long way off India's target growth rate of closer to 7%-8% per annum. In our main economic projections, we expect GDP growth to be around 6.5% in the medium-term unless more fundamental reforms are pushed through in future years.

Similarly, inflation remained above the government's comfort zone due to higher food prices. However, we expect the inflation rate to stabilise in the region of around 5-6%  this year on the back of monetary tightening at the beginning of 2014.

The twin deficits

Fiscal and current account balances as a proportiion of GDP.

Fig 3: Fiscal and current account balances as a proportiion of GDP.

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As we pointed out in the May edition of the Global Economy Watch, quick and decisive action on structural reforms are key factors that could help boost investment levels in India and increase its medium term growth prospects. However, this is challenging as India faces persistent high fiscal and current account deficits (see Figure 3), which in turn reduces the government's policymaking flexibility.

However, the new government has already started to put in place measures to bring down the fiscal deficit from 4.5% in FY2013-14 to 4.1% of GDP in FY2014-15 and further down to 3.6% of GDP in FY2015-16, as show in Figure 3.

Similarly, government projections show that the current account deficit is expected to stabilise at around 2% of GDP, as compared to 4.2% in FY 2011-12.

Still a long way to go

So what were the key measures included in the budget? Here are a few that are relevant for business:

  • Liberalising the defence and insurance sectors by raising foreign investment caps to 49%;
  • Plans to develop roads, railways and improve infrastructure in cities in partnership with private sector players; and
  • Tax reforms to hasten a uniform Goods and Services Tax (GST) regime across the country.

Realistic but not bold

The new government's maiden budget is realistic, but lacks the bold measures that some commentators expected after the landslide election victory. We think this is because the government wants to focus on implementing and consolidating these reforms before introducing any other major changes.

However, we also think that the announced measures are insufficient to push GDP growth rates to the  target rate of 7%-8% within the next 3-4 years as a lot more needs to be done to improve manufacturing productivity and output.