| NEW DELHI/MUMBAI, April 8
NEW DELHI/MUMBAI, April 8 From convincing
sceptical bond investors that the fiscal deficit can be
contained to concerns that El Nino will devastate agricultural
crops, any new government in India will face urgent and critical
challenges with no easy solutions.
Expectations the Bharatiya Janata Party (BJP) and its leader
Narendra Modi will win elections that started this week with a
new approach to India's economic problems have helped send
shares to record highs and the rupee to an eight-month
To some investors that optimism is misplaced. Should Modi
win the elections, his government will face its first
credibility test with markets when he delivers a budget by June
or July that will need to show the country can realistically
contain its fiscal deficit.
That will be followed by key decisions on the current
account deficit, on the relationship with a hawkish central
bank, on how much funds to sink into troubled state lenders, and
on how to get states to promote private investments.
The BJP promised fiscal discipline and banking reforms among
other policy plans when it announced its election manifesto on
Monday, but gave no details.
Below are five key challenges facing a new government, none
of them easy to fix.
1. DELIVERING A BUDGET THAT CONTAINS THE FISCAL DEFICIT
Any new government will need to fix finances that are in
dire straits, and about to get worse.
To achieve a revised fiscal deficit target of 4.6 percent of
gross domestic product (GDP) for the year ended in March, the
Congress-led government cut spending by $13 billion and pushed
about $16 billion in subsidy costs into the new year.
That austerity could prove hard to sustain. Spending
accounts for 11 percent of India's GDP, offering a critical
growth lever. Continuing to defer payments to state-run
companies that would compensate them for selling fuel,
fertiliser and food below market prices, can create havoc with
their finances and make them rely on borrowings to fund
Meanwhile, tax revenues are unlikely to recover immediately
in a weak economy. The government's tax-to-GDP ratio has slipped
to 10.2 percent from a peak of 12.5 percent in 2007/08.
The interim budget from Finance Minister P. Chidambaram in
February was greeted with widespread scepticism.
It sought, for example, seek to contain the fiscal deficit
at 4.1 percent of GDP in 2014/15, the lowest in seven years,
while keeping spending growth at just 10.9 percent compared to a
recent average of about 15 percent.
Finance ministers in the past six years have sold an
ever-growing amount of debt to bond investors, a solution
unlikely to please markets as it pushes liabilities to the
A realistic and fiscally prudent budget is also critical
given Standard & Poor's Ratings Services has a negative outlook
on its "BBB-minus" rating for India, and has said the policy
agenda from a new government will determine whether the country
can avert a downgrade to "junk."
2. NARROWING THE CURRENT ACCOUNT DEFICIT
A sharp narrowing in the current account deficit, to an
expected 2 percent of GDP from a record high 4.8 percent in the
previous fiscal year, was helped by steps to curb gold imports.
Higher duties and other restrictions almost halved gold
imports but the moves have been deeply unpopular with Indian
households who invest in the yellow metal to protect their
savings from inflation and to provide gifts at weddings and on
other special occasions.
Gold smuggling is also suspected to have surged after the
measures, casting doubt on the reported data.
The BJP has promised to review gold import duties within
three months of coming to power. Getting rid of them may please
gold buyers, but not investors, as concerns about the current
account deficit had sent the rupee to a record low in
Fixing the structural challenges that keep the current
account deficit wide - such as weak manufacturing exports -
could take years to reverse.
3. DEALING WITH RBI AND EL NINO
A new government may face a factor beyond its control: the
El Nino weather pattern typically associated with weak rains.
Analysts caution El Nino could batter Indian agricultural
output. Citigroup estimates that below average rainfall in the
June-September monsoon could shave 0.50-0.90 percentage points
off its economic growth forecast and lead to a spike in consumer
A good monsoon last year was one spot of relief in an
otherwise bleak economic picture with growth estimated at less
that 5 percent in the fiscal year that ended on March 31, close
to the slowest in a decade.
Surging inflation could also spark tension with a central
bank that under Governor Raghuram Rajan has made containing
inflation a priority.
The Reserve Bank of India (RBI) wants to bring down annual
consumer price inflation to around 6 percent from the current
8.1 percent by January 2016, which would likely mean more
interest rate increases. The RBI has raised rates three times
4. REVIVING THE PRIVATE INVESTMENT CYCLE
Market hopes on Modi lie largely on perceptions of his track
record as chief minister in Gujarat, where he is widely credited
with attracting investment.
However, analysts say replicating that nationwide would be
difficult given that states wield much of the power in approving
projects. Credit Suisse estimates only one-fourth of pending
projects depend on central government approval.
In its manifesto, the BJP promised to cut red tape and
encourage foreign investment in sectors needed for job and asset
creation. But it said it was opposed to foreign investment in
Capital investment contributes nearly 35 percent to India's
economy, but it barely grew in the fiscal year that ended in
March as delays in clearances and funding issues grounded many
That is particularly the case with state electricity boards,
which remain hobbled by losses caused in part by costly fuel and
little pricing power.
Short of recapitalising state utilities, the central
government has few choices in pushing for a restructuring. Coal
supply is also a key constraint, in large part due to the
financial difficulties at state power generators.
5. RECAPITALISING STATE-RUN BANKS
India needs to fix the piles of bad loans at the country's
state-run lenders, with stressed loans totalling $100 billion,
or about 10 percent of all loans.
The bulk of these bad loans are related to infrastructure
projects, which have made banks circumspect in lending.
The interim budget set aside 112 billion rupees ($1.87
billion) to help the sector meet minimal capital ratios mandated
by Basel III norms, but more will be needed, according to
analysts, creating tough fiscal choices for a new government
The BJP has tended to lean towards privatisation, raising
the prospect of stake sales, although the party has not
addressed the issue in the run-up to the polls.
($1 = 59.8050 Indian Rupees)
(Editing by Raju Gopalakrishnan)