Modi has a long list of challenges to tackle in his second term, say economists

From growth revival to job creation to land and labour reforms, there are many economic challenges that need the new Modi government's intervention.

File photo of PM Narendra Modi and Amit Shah | Photo: PTI

New Delhi: Prime Minister Narendra Modi has won the BJP-led NDA government its second consecutive term with an absolute majority in the Lok Sabha.

But as soon as it takes office, there are several immediate challenges that need intervention on the economic front.

Growth revival

India’s economic growth is expected to slow down to less than 7 per cent in 2018-19 from 7.2 per cent in 2017-18 and 8.2 per cent in 2016-17. Tackling the growth slowdown, given the constraints on spending due to the tight fiscal position, will be a major challenge for the Modi government.

Data such as the Index of Industrial Production (IIP) and Purchasing Managers’ Index (PMI) indicate a broad-based demand slowdown in the economy, said D.K. Srivastava, chief policy advisor, EY India.

“The immediate task before the new government is to stimulate demand in the economy and uplift investment sentiments,” he said, adding that another rate cut in the monetary policy review should be accompanied by a fiscal stimulus.

Investment, consumption push

Reviving private investment remains a big challenge for the new government, something it failed to do in Modi’s first term, where it followed a policy of public investment-led push to growth.

The slowdown in consumption reflected by slowing auto sales and falling demand for fast moving consumer goods will be another problem for the government to contend with.

The government has been the main driver of capex in the last two to three years, said Madan Sabnavis, chief economist at Care Ratings.

“The focus must now be on reinvigorating private investment, and here it would be necessary to review the clogs that are in the way of investment. Besides looking at further improving the ease of doing business, the government must look at tying up other ends such as taxation, credit, regulation (where sectors have regulatory issues), environment etc. to ensure there is a pick-up in investment,” he said.

Sabnavis added that tax cuts are crucial for reviving consumption but may not be possible given the fiscal constraints.

Tackling imminent crisis in financial sector

The threat of default is looming over many non-banking financial companies (NBFCs), including housing finance companies, because the liquidity squeeze after the IL&FS default brought the asset liability mismatches to the forefront.

The government will have to work closely with the financial sector regulators to avoid a financial sector collapse and assure the markets of sufficient liquidity.

Shubhada Rao, chief economist at Yes Bank, said though severe stress emanating from the IL&FS crisis has been ring-fenced, the balance sheets of NBFCs are undergoing adjustments, which is impacting sectors like automobiles and housing.

“We believe a comprehensive policy response encompassing the Ministry of Finance, RBI, and SEBI would be required for accurate diagnosis, recognition, and time-bound resolution of the current problems,” she said in a note Thursday.

The unresolved non-performing assets (NPA) issue faced by the Indian banking sector will be another priority area for the new government.

Reining in fiscal deficit, boosting tax buoyancy

With tax revenues slowing significantly, the Modi government will have the unenviable task of bringing down its fiscal deficit while increasing public investment to boost growth.

India revised its fiscal deficit target upwards to 3.4 per cent from 3.3 per cent for 2018-19 in the Budget, despite classifying many of its expenditures as off-balance sheet exposure. The implementation of the goods and services tax (GST) and demonetisation did not bring in the anticipated increase in tax buoyancy, while a lower-than-anticipated nominal GDP growth saw the tax collections falling.

Thomas Rookmaaker, director at Fitch Ratings’ Asia-Pacific Sovereigns team, said in a note that the new government’s effort to improve India’s weak fiscal finances would be important from a perspective of its credit ratings.

“Fiscal consolidation stalled under the BJP in recent years, and its campaign promise to support farmers’ incomes has added to spending pressure,” he said.

He added that “there has been little indication so far that the government will pursue significant deficit reduction of the order needed to meet the general government debt ceiling of 60 per cent of GDP by March 2025, as mandated by the FRBM Act”.

Land and labour reforms

Many economists, including India’s chief economic advisor Krishnamurthy Subramanian, have stressed on the need for bringing in land and labour reforms — a task which the Modi government initiated in its first tenure but was unable to push through.

Labour reforms are necessary from the point of industrial flexibility as well as employment, Sabnavis said, adding “economic cycles are going to be the norm and industry expects to have some degree of flexibility here”.

Rural distress

Economists argue that a slew of loan waivers by state governments and the income transfer scheme announced by the Modi government are not adequate to address rural distress, and the government will need to bring in long-term policies to support agriculture.

Sabnavis stressed the need for focusing on both productivity and price realisation.

“The former requires the Centre to work with the states to ensure that the input package provided, which includes seeds, irrigation, credit, fertilisers and pesticides is comprehensive and well integrated. At the price level it would be necessary for the government to work to make the MSP more effective,” he said.

Job creation

Addressing rising unemployment will remain a challenge for the Modi government after the unemployment rate touched a record high of 6.1 per cent in 2017-18.

Economists stressed the need for incentivising labour-intensive manufacturing to generate jobs for the youth.

“To begin with, the government must look internally and fill up all the vacant positions that have been on hold. This can hold for the entire public sector. For private sector employment generation, the government needs to focus on the SME segment as well as start-ups so as to increase the opportunities,” Sabnavis said.

External sector challenges

The uncertainty around oil imports after the Iran ban, as well as the trade war between the US and China, have increased the uncertainty for India on the external front. Rising oil prices and a falling rupee could add pressure on India’s current account deficit.

“In the near term, worsening of international trade prospects could create a global risk aversion ripple, thereby putting depreciation pressure on EM currencies, including INR,” said Rao.