It is widely held that the significant parliamentary majority won by the BJP/NDA in the country’s 2014 election reflects the electorate’s desire for economic change. But the changes sought by approximately 540 million voters may vary with their age, income, occupation and location. For individuals, economic concerns could range from accelerating inflation to fading employment prospects. For some businesses, currency volatility may be the most pressing issue, while for others it is high interest rates.
Nonetheless, each of these apparently disparate issues is linked to one of the three factors, described below, that represent India’s key long-term challenges. These three factors are high fiscal deficits, recurrent inflationary pressures and a shortfall in infrastructure.
High fiscal deficits
Even after a reduction over the last two years, the country’s fiscal deficit ratio remains higher than the median for similarly rated countries. The relatively high budget deficits keep the government’s debt and interest payment burden above that in comparable countries. This weak fiscal position is a constraint on India’s Baa3 sovereign rating.
Wide fiscal deficits stimulate demand on the one hand, but by raising government borrowing, they also ‘crowd out’ the private sector’s access to domestic savings, aggravating the supply constraints that dampen investment. This combination fuels inflation, reduces economic competitiveness and eventually limits GDP growth. Moreover, as India’s economy has become more open, the above-mentioned effects of loose fiscal policy have exacerbated external imbalances. This was evident in 2013, when the economy became particularly vulnerable to capital outflows due to the confluence of high inflation, a wide current accountdeficit and muted growth prospects.
Recurrent inflationary pressures
India’s high inflation reflects the mismatch between the country’s robust domestic demand and tight supply. As described above, fiscal policy exacerbates this mismatch. In addition, India’s regulatory and operating environment discourages foreign and domestic investment in certain sectors, limiting the increase in supply to meet demand. For example, poorinfrastructure and regulatory restrictions keep the country’s agricultural productivity below levels in comparable countries, stoking food inflation. As supply-side constraints on inflation persist, interest rates have been increased in order to check inflation. High interest rates, in turn, further limit investment growth.
Infrastructure shortfall
The country’s infrastructure development has been inhibited by a lack of financing as the government’s resources are limited and project implementation risk is too high to attract private investment. If conditions that encourage infrastructure financing are created, the consequent boost to infrastructure would also help accelerate growth and reduce inflation.
(The writer is VP & senior credit officer, sovereign risk group, Moody’s Investor’s Service)