Why PM Modi can shrug off Rahul Gandhi's populist challenge, for now

Even with a bumper tax harvest the federal government will just about meet its targeted budget deficit of 6.4% of gross domestic product for the fiscal year that ends on March 31

Given that it’s his last, big spending opportunity before next year’s general elections, it won’t be unreasonable to expect Prime Minister Narendra Modi to sprinkle the Feb. 1 government budget with a dose of populism. This is especially so, as Rahul Gandhi, his main political opponent, is on a grueling months-long trek, walking from the edge of the Indian Ocean in the south to Kashmir in the northern Himalayan region, trying to whip up passion around everyday issues like unemployment and inflation.

Yet, the budget might at best pander to the middle class by some cosmetic tinkering with income-tax slabs. I’ll be surprised if the administration suddenly decides to push mass consumption by diluting its single-minded devotion to investment. An expansion of the welfare state — better old-age security and higher maternity benefits, for instance — is equally unlikely, even though it will help Modi counter Gandhi’s accusation that his government is working only for a few rich tycoons, such as Gautam Adani and Mukesh Ambani, two of the the world’s wealthiest people.

The global economy is slowing. The US Federal Reserve is determined to wring inflation dry. China’s aggressive reopening is likely to put some pressure on raw-material prices. And Japan appears to be losing control of its hyper-easy monetary policy. Against this backdrop, India will be hesitant to make costly commitments. Even with a bumper tax harvest — thanks to faster-than-expected domestic inflation — the federal government will just about meet its targeted budget deficit of 6.4% of gross domestic product for the fiscal year that ends on March 31.

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To that, add state-level resource shortfalls, power distribution utilities’ chronic losses, an expected 3%-plus of GDP in current-account gap, and a sticky 6% core inflation — India’s macroeconomic imbalance is already among the worst across major economies. The good news so far has been high post-Covid-19 growth. That’s now slowing, partly because export demand is starting to wobble and partly because the central bank in Mumbai has also had to raise interest rates. A focus on stability may serve India better than a desperate priming of the fiscal pumps.

Modi’s core economic agenda is to promote India as a rival manufacturing destination to China. He has sought to achieve this by incentivizing private factory expenditure and allocating more state resources to infrastructure, particularly rail and road. Banks have ramped up credit, and capital-goods manufacturers have chalked up new business. Their order book in September was 3.8 times revenue, compared with 2.9 times in March 2019, according to Crisil, an affiliate of S&P Global Inc. These firms will expect New Delhi to stay the course by funneling more taxpayers’ money into what is widely believed to be the start of a long investment cycle with global repercussions: India’s steel demand, which has already overtaken the US, is expected to grow the fastest in 2023 among large economies. 

Sustaining the construction boom will require funds. This month, the government discontinued a pandemic-era free food program for 800 million Indians. With some luck, it might also save some money on fertilizer subsidy, which surged after the war in Ukraine caused international prices to spike. Cutbacks like these will get transferred to investors via a five-year, $24 billion program of production-linked incentives for manufacturers of everything from semiconductors and electric-vehicle batteries to textiles and perhaps even toys. A supply chain for Apple Inc.’s products is taking root, with more vendors to the Cupertino, California-based behemoth getting permission from India to set up shop.

However, uncertain global demand and lackluster domestic consumption may keep a lid on private investment. The Indian government’s own capital expenditure will have to do the heavy lifting. A repeat of the 63% jump between April and November would be hard to finance without leasing out existing state assets to private players to raise money. Trouble is, the same acquisitive billionaires that Gandhi is complaining against in his speeches for their perceived proximity to the government are also likely to be the most eager to invest in roads, railway stations and airports. Modi managed to sell the loss-making Air India to Mumbai’s Tata Group 15 months ago. That was timely. The political space for privatization might shrink as elections draw near.

Overall, New Delhi’s spreadsheets are likely to show half a percentage point cut in the projected annual deficit for the year starting April 1. That will still leave annual government borrowings at a much higher level than before the pandemic. But at least rating companies can chalk up the promise as “expected fiscal consolidation” and leave the sovereign rating unchanged at the last rung of investment-grade ranking. Whether there’s any actual pressure from the bond and currency markets to achieve the deficit-reduction target will become clear only during the year.

So far the markets haven’t paid much attention to a slow shift toward more populist policies. In some states where opposition parties, including Gandhi’s Congress, have won elections recently, they have reintroduced an old defined-benefit pension plan for local government employees. This is a dangerous trend. To give up on 20 years of progress in making workers contribute to their old-age security and return to guaranteeing half of their last-drawn pay will create a burden on future taxpayers. Perversely, it will also lead to less welfare funding targeted at the bottom of the socioeconomic pyramid. Even if Modi ignores this challenge, Gandhi might strike back by renewing his 2019 promise of a basic income for the poorest 50 million families at a time when the jobless rate in cities is still high at 10%.

Expect a fairly cautious budget on Feb. 1, but don’t rule out the risk of a slippage during the year if political pressures mount just as growth slides.