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Economic Risks Have Begun To Recede, but...

Monday, June 23, 2014
By Dominic Rebello

The government faces a difficult challenge and it is being believed that it will be a long time before the economy expands at its potential rate of around 7%

India's economy has 'stabilized and should soon emerge from its current slump. The worst of the downturn has now passed and downside risks have begun to recede, helped by the actions of the previous government during its last days, says Moody's Analytics in a report.

The economy grew 4.6% in the opening quarter of 2014 and has been growing around this pace for the past two years, “but should slowly accelerate from the second quarter. That said, the incoming government faces a difficult challenge, and it will be a long time before the economy expands at its potential rate around 7%” adds Moody's. According to  Glenn Levine of the Asia-Pacific Staff of Moody’s Analytics, “there are emerging signs that the economy is improving, albeit slowly”. Industrial production grew 3.5% y/y in April, its fastest pace in 12 months, while May exports outperformed. The current account deficit has also narrowed, prompting the government to lift some restrictions on gold imports. The consumer price measure has cooled, but inflation remains elevated, according to the wholesale price index.

With risks receding and the economy stabilizing, the stage is set for the new government of Narendra Modi to offer fresh ideas to drive development. India's under-performing economy was the biggest issue of the recent election campaign, and Modi won a clear mandate to make tough decisions. He enjoys a sizable parliamentary majority in the lower house as leader of the National Democratic Alliance, led by the Bharatiya Janata Party.

The government must move from damage control to longer-term thinking. As chief minister of the state of Gujarat, Modi boosted the state economy by reducing red tape and approving investment projects. Early signs from the new administration are promising. The government has indicated that it may allow more foreign investment in defense, railways, construction and online retail. Multibrand retailing, however, which gained traction under the previous government and would be a boon for the country’s consumers and infrastructure advancement, will not be opened up.

A tighter national budget is expected in July, the first of five during the government’s term. First on the chopping block will be expanded welfare payments pushed through by the previous administration in its last days. There has also been talk of scaling back fuel subsidies. Austerity will lower the near-term economic outlook, but will help balance the budget and restore confidence longer term.

Outside the budget, there is plenty for Modi to do. “His government should move quickly to push through long-stalled legislation covering environmental regulation and the goods and services tax. Only 3% of Indians pay income tax, so broadening the tax base must be a priority. Perhaps the simplest but most important move the government could make is to reverse taxes applied mostly to foreign companies retroactively under the previous administration. The uncertainty created by this policy, as well as the previous government's hostility to foreign businesses, damaged confidence and thwarted investment. Reversing this would provide a clear break from the past and show that India is open for business again” advises Moody's.

'There is plenty for prime minister Modi to do. His government should move quickly to push through long-stalled legislation covering environmental regulation and the goods and services tax. Only 3% of Indians pay income tax, so broadening the tax base must be a priority. Perhaps the simplest but most important move the government could make is to reverse taxes applied mostly to foreign companies retroactively under the previous administration. The uncertainty created by this policy, as well as the previous government's hostility to foreign businesses, damaged confidence and thwarted investment. Reversing this would provide a clear break from the past and show that India is open for business again', advises Moody's.

'Abki Baar Dikha De Yaar, Chala Sakta Hai Modi Sarkar', that’s the chant echoing in response to Modi's election winning line –
'Abki Baar Modi Sarkar'. So will he?

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