Adding arrows to new regime’s policy quiver

An economy which is performing several steps ahead of its peers, does not need an overhauling of the policy framework.

With the electoral process now behind us, the focus has shifted to the government formation and markets are speculating on the possible policy directions of a coalition government after 10 years. To start with, the general domestic macro backdrop is quite favourable for the new government. FY24 Gross Domestic Product growth (GDP) at above 8% is encouraging and the momentum seems to be continuing even in FY25. India is probably the only large country demonstrating above-average growth that is also accelerating further. Macro stability parameters of inflation, current account and fiscal deficit are within the broad comfort zone.

As we neared the end of 2022-23, there was near-consensus on real growth. The cited figure was between 6.8 and 7%. There is less consensus for 2023-24 and the medium-term. An optimist will say 6.5%, a pessimist 5.5%. An enthusiastic optimist will place it at 7%, a dire pessimist at 5%. While that’s a fairly broad band, there is no denying the Indian economy’s growth resilience. (Shutterstock)

This probably suggests that there is no immediate need to change the overall policy thrust of the government which has been a two-pronged approach. One, emphasis on the supply side through infrastructure, manufacturing, digital and technology, and two, focus on macro and financial stability to provide a long runway to growth.

Based on a closer scrutiny of the election results, the government will have to decide what needs to be added to the objective function. In particular, there could be two directions in which new ideas and policy actions might be spread. First, if voting data provides some support to the hypothesis that there is considerable distress among the rural/poor/youth, then the government might contemplate some demand boosting/redistribution strategies. Second, if there is an aspiration to push India’s potential growth even higher, then further productivity-boosting reforms will have to be considered to attract capital along with better deployment of human resources through large-scale job creation.

Let us delve into the specific policies if these are the broad objectives that the government would want to push. On the supply side, the earlier government has already laid out a comprehensive plan with a combination of infra build-up to reduce logistics costs, trade policies to protect competitiveness and industrial and fiscal policies to enhance profitability. It will be important for the government to continue with these and hence not take the foot off the pedal on infra capex. Depending on the success of the PLI schemes, they can be extended to other sectors. Digital India is on auto-pilot now and would not need much government handholding. It will be interesting to see how the new government ramps up the proposed R&D fund to usher in advanced technologies.

Over the last 10 years, the government has steadfastly improved the macro and financial stability parameters to shed the “Fragile Five” tag. Progress on this front has been quite remarkable, though in an uncertain global environment, there is no scope for complacency. We would expect the upcoming budget to respect the 5.1% of GDP FY25 fiscal deficit target announced in the interim budget as a red line to keep the country on track with debt reduction. The rating agencies are warming up to the idea of considering an upgrade and foreign bond investors are increasing their allocation towards India on the back of index inclusion. Adhering to macro stability would be integral to progress on these fronts and the budget document needs to reconfirm the government’s commitment to the fiscal glide path.

The new government will have to find a balance between the macro stability objective and the need for a demand nudge if a requirement of that is felt. We think that given the higher RBI dividend and lower fiscal deficit for FY24 (5.6% of GDP vs 5.8 earlier), there is ~0.4% of GDP additional fiscal space available to the government for FY25 even if they want to meet the exact interim budget target of 5.1% of GDP. Targeting this additional expenditure would obviously involve not just economic but also political considerations. In this economic cycle, the demand side has been lagging the supply side in our view and hence, a calibrated demand nudge should not be immediately inflationary but one needs to be also mindful that the fiscal bonanza from the RBI dividend might not be available every year to run large populist schemes.

The contentious structural reforms (land, labour, legal, agriculture, privatisation) to improve the productivity of businesses might have to wait for the coalition government to become more cohesive and credible. We do acknowledge that a lot of economic policy agenda can be pushed through executive action rather than requiring legislative approval and surely does not need any super majority in Parliament. It is important for the government to keep business optimism high to take advantage of the favourable tailwinds, like the drifting of global capital towards India. Also, we think that domestic private investment is already in a nascent recovery stage and would benefit from constructive support from government policies. Even if the structural macro reforms are delayed, there could be several micro-level reforms to unclog regulatory bottlenecks, provide predictability to the policy environment and improve the ease of doing business.

If the assessment is that lack of job opportunities was a deciding factor in the election, then employment creation could move up on the economic agenda of the new government. India’s labour market is multi-layered, and the employment strategy would have to be more nuanced too. At one end of the spectrum, manufacturing and high-end services would fulfil the needs of the skilled workforce. However, at the other end, a renewed focus on skill development or channelising more credit to foster self-employment is essential for the 250 million people who have been brought out of poverty in the last 10 years.

An economy which is performing several steps ahead of its peers, does not need an overhauling of the policy framework. Judicious additions to the bouquet would prepare it for higher growth with better distribution.

Samiran Chakraborty is managing director and chief economist India, and Baqar Zaidi is economist, Citigroup. The views expressed are personal