The country is facing multiple macro challenges — high interest rates, slowing investments, depreciating currency and policy challenges — the list is long. The root cause of most of these problems is the elevated current account deficit (CAD) and a runaway fiscal deficit. The urgency with which these deficits need to be addressed cannot be emphasised enough. Therein lies the rub — the current political environment makes it very difficult to address these issues with the firmness they so urgently deserve.
The case in point is subsidies. The Indian consumer has not had to face the inconvenience of rising oil prices, farmers have seen rising subsidies on fertilisers and rising food prices have not been passed on to the beneficiaries of the PDS system. The government’s reluctance to face up to the subsidies has meant high borrowings — causing significant burden on monetary policy and high interest rates, which are slowing down growth.
The lack of resources is leading to the government's scamper for revenues, which is manifesting itself in regressive tax policies. Instead of solving the expenditure issue, the government is causing a further hit to the investment climate.
In a scenario of status quo, it is likely that the investment cycle would be incrementally edged out by consumption and trend growth expectations would slide. An even more damaging scenario could emerge if the government reverts to more populism. In that case, the currency and rate cycle could be worse than expected. While growth getting hit by the investment cycle due to policy related issues, at the present level of CAD it is difficult to accommodate additional demand from higher investments. Thus, it is hard to see a revival in growth without a correction in fiscal policy.
So, will the government act in a way that inconveniences the voters — by raising fuel prices, cutting fertiliser subsidy and not increasing the food subsidy bill.
As the government at the centre has weakened, following losses sustained in recent state elections, politics at the centre would continue to remain vulnerable to populism.
So, we are left with two conclusions: (a) the central government is unlikely to precipitate elections given the recent losses at the state levels, thereby weakening the will to reduce the fiscal deficit, and (b) given the weak position at the centre, the government could indulge in populism. For example, if it were to accept the recommendation for a 25 per cent rose in minimum support prices for food grains, there would be a big overshoot on the food subsidy bill.
India’s story stands at a juncture where the actions of the past would cause some economic distress, and more could follow if course correction is not taken. Markets would not be immune to these stresses in the economy and would remain lacklustre, if not downward trending, over the next few months.
The writer is Managing Director, Nomura Financial Advisory & Securities (India)
