“S&P - the sole agency that maintains a “negative” outlook - has stated that “fiscal prudence” remains paramount. But it is apparently inclined to consider the extent to which the new government is able to put in place a better enabling environment for growth more broadly”.
- Anjalika Bardalai,Senior Analyst at Eurasia Group
One of the key questions being asked by policy analysts and investors alike is the extent to which the new government is prepared to continue the process of fiscal consolidation spearheaded by outgoing finance minister P. Chidambaram.Speculation is still rife as to who will serve as finance minister in the new administration, but Chidambaram's successor is certainly unlikely to commit to his specific targets, which envisioned the budget deficit falling to the equivalent of 4.2 per cent of GDP in the current fiscal year (FY2014-15) and 3 per cent by FY2016-17.Chidambaram′s successor is also unlikely to stake his reputation on this single issue to the extent that Chidambaram did. Chidambaram′s insistence on meeting deficit targets was prompted by international ratings agencies′ threats to downgrade India′s sovereign credit rating, which would push it below investment grade.But that pressure has since eased: one of the two agencies that had downgraded India's sovereign credit outlook to “negative” (Fitch Ratings) has since revised it back up to “neutral”. S&P - the sole agency that maintains a “negative” outlook - has stated that “fiscal prudence” remains paramount. But it is apparently inclined to consider the extent to which the new government is able to put in place a better enabling environment for growth more broadly. Higher GDP growth would not only arithmetically improve the key sovereign credit metrics, it would also go some way to achieving a material reduction in the budget deficit by boosting tax revenue.Moreover, the outgoing government made extensive use of off-budget financing to achieve its headline budget-deficit target - a fact which was tacitly acknowledged by the ratings agencies as well as India-watchers. The Modi administration may choose to make explicit what has heretofore been implicit, perhaps as a means of discrediting the outgoing government and starting with a fresh slate. If combined with a credible new strategy for medium-term fiscal consolidation, this could actually have the effect of appeasing the ratings agencies and going some way to address one of India's structural economic imbalances.
- The new government's deficit-reduction arsenal could include, among other things:
- accelerated “disinvestment” of shares of state-owned companies (though full-scale privatisation is likely off the cards)
- caps on existing welfare and subsidy payments (fuel subsidies are a prime target for being rolled back)
- increases to the corporate tax rate, and/or the introduction of new indirect taxes
- an iron-clad commitment to implementing the long-mooted Goods & Services Tax (if the new government were to accede quickly to the various concessions demanded by India′s state governments, the prospect of the requisite legislation being passed in the upper house of parliament - where the BJP does not even command a plurality - would increase significantly)
- Given the extent to which Chidambaram slashed capital expenditure in recent years in order to meet his deficit targets, the new government - with its focus on raising GDP growth - will be unlikely to implement wide-ranging spending cuts in the near term. But employment of some or all of the measures outlined above, combined with a return to more robust economic growth, will have the effect of quietly and gradually strengthening the public finances - even in the absence of Chidambaram-style melodramatics.
In this regard, the full FY2014-15 Budget, which is due to be presented next month in the new government's inaugural parliamentary session, will be a key signpost of the government's emphasis on fiscal consolidation as well as its economic policy priorities more broadly.
Anjalika Bardalai is a Senior Analyst at Eurasia Group, focusing on South Asian international relations and monetary and fiscal policy in India and Pakistan. Prior to joining Eurasia Group, Anjalika spent 12 years with the Economist Intelligence Unit (EIU).
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