Five challenges for Narendra Modi's new Indian government

May 16 2014, 21:10 IST
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The austerity of the UPA could prove hard to sustain by 'PM' Narendra Modi. (Reuters) The austerity of the UPA could prove hard to sustain by 'PM' Narendra Modi. (Reuters)
SummaryThe most urgent challenges facing Narendra Modi's government have no easy solutions.

A landslide election victory for Narendra Modi's Bharatiya Janata Party (BJP) has created euphoria in India's financial markets, driving shares to life-time highs and the rupee to its strongest level against the dollar in 11 months.

After a decade in opposition, Narendra Modi's BJP has promised to repair an economy growing at its weakest rate since the 1980s and tackle stubbornly high inflation.

However, the most urgent challenges facing the government, from a large budget deficit to concerns that the El Nino could devastate agricultural output, have no easy solutions.

Below are five of the biggest tasks:

1. DELIVERING A BUDGET THAT LIMITS THE DEFICIT

Modi's government will face its first credibility test with markets when it delivers a budget by July that will need to convince investors that India can realistically contain its fiscal deficit.

To meet a deficit target of 4.6 percent of gross domestic product (GDP) for the year that ended in March, the outgoing 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 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 borrowing to fund operations.

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 of the outgoing government in February was greeted with widespread scepticism. It sought, for example, 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.

Standard & Poor's has a negative outlook on its "BBB-minus" rating for India, and has said the new government's policy agenda will determine whether India can avert a downgrade to "junk" status.

2. NARROWING THE CURRENT ACCOUNT DEFICIT

A sharp narrowing of the current account deficit, to under 2 percent of GDP in 2013/14 from a record high of 4.8 percent the previous 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. Gold smuggling surged after the measures, casting doubt on reported data.

The BJP promised to

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