Modi`s Victory: What awaits Indian economy

New government will have to make constant efforts to retain the optimism of foreign investors and win back the investors` confidence.

By Ajeet Kumar | Last Updated: May 24, 2014, 23:11 PM IST

Ajeet Kumar/Reema Sharma

Buoyed by the spectacular performance of BJP-led NDA in the 2014 General Elections, markets have responded with a thumping rally. The BSE Benchmark Sensex has zoomed past 25K level while the 50-share Nifty surged to new all-time high of 7,563.50. The Indian rupee also recovered up to 58.68 against the US dollar. But the main concern is the sustainability of the current rally which will finally be driven by the fundamentals of our economy that is yet to get back on track. Short term excitement will not be able to fuel the steam in the long run.

Most of the market experts believe that markets have already consumed the euphoria of the Modi wave and the next course of government`s action on the economic front will finally determine the direction of the market.

The major challenge before the new government is to kick-start the growth rate cycle, which is crippling under 5 percent. One of the key reasons of the slowdown in the last two years was the dismal performance of overall industrial growth.

Industrial growth remained almost flat in 2013-14 percent compared to the expansion of 1.1 percent in 2012-13. The BJP-led NDA government must take decisions that will push up the industrial growth. This can happen only by lowering the high interest rate. Though it remains to be seen as to how the Reserve Bank of India (RBI) will reverse its hawkish stance on monetary policy front considering that the retail inflation, measured on consumer price index (CPI), is still hovering at a three-month high of 8.59 percent in April.

Economic facts and figures might not be the only indicators of economic turnaround. It will also be determined by its inclusiveness - poverty eradication, employment generation and social security.

The other challenge before the Modi government is that it needs to tackle the forecast of a weak monsoon if the El Nino appears. The government must be ready to face the crisis arising out of poor rains which is likely to affect the production of Kharif crops in India, thereby stoking consumer inflation in the later half of this year. If this type of scenario arises, it will make RBI`s task even tougher.

Battle on the fiscal front will also be a daunting task for the new government. Challenges like containing twin deficit - current account deficit (CAD) and fiscal deficit - will continue to test the government`s ability. However, the outgoing UPA government has succeeded in containing the CAD to a certain level by curbing gold imports. But, the long term solution lies in containing the mounting trade deficit either by improving exports or lowering imports. BJP government has to make sure that there is a balance in doing so. The UPA tried to tackle fiscal deficit concerns by cutting spending and deferring payment to state-run oil companies for the new year. But this austerity could prove hard to sustain in any emerging economy.

The Modi government should adopt a pragmatic approach towards subsidies - mainly fuel and food - without bothering much about a short term political gain.

New government will also have stay away from pumping excessive money to keep the ailing public sector units (PSUs) afloat. It should also seriously consider getting rid of some of the sick units which have become a complete liability for the government. A cautious and balanced approach on divestment should be the priority of the new government.

For better employment generation and attracting FDI inflows, BJP must take an investor-friendly stand on foreign investment reforms. It should take lessons from the outgoing UPA government which has been long accused of policy paralysis. Although, the BJP election manifesto had room for FDI across all sectors, it was against FDI in multi-brand retail. Modi will have to rethink the party`s position and take the decision on its merits rather than getting swayed by popularism.

FDI inflows into the country have been declining over the past two years despite policy easing in about a dozen sectors. For the April-February period of last fiscal, FDI inflows dipped 0.6 percent to USD 20.76 billion. In full 2012-13 financial year, the inflows were down 38 percent to USD 22.42 billion compared to the previous year.

Modi government will have to make constant efforts to retain the optimism of foreign investors and win back the investors` confidence. Implementation of tax reforms like goods and service tax (GST) can prove to be a good bet for the investors. Government should also make its stand on retrospective tax clear.

The new government also has to bite the bitter pill in order to achieve a sustainable growth. It certainly has inherited a lot of fiscal burden from the previous regime. The new government will not only have to lessen that load but also take holistic measures so that India can chart a new growth history.