India: A new wave of policy changes in “Modi-fied” India

In spite of a period of pronounced geopolitical risks, developed economies are experiencing modest growth, and growth in developing economies is stabilizing.


Narendra Modi has been sworn in as India’s prime minister. The single-party majority has set the foundation for a stable central government for the next five years. Political stability has significantly reduced downside risks to the economy. However, significant challenges lie ahead for the new government.


The third quarter edition of the Global Economic Outlook offers timely insights from Deloitte Research economists about the United States, the Eurozone, China, Japan, India, Russia, Brazil, and the United Kingdom.

By Dr. Rumki Majumdar, macroeconomist and a manager at Deloitte Research, Deloitte Services LP.

The general election that concluded on May 16, 2014, broke several electoral records. It recorded the highest-ever voter turnout (551.3 million) and the highest-ever voter participation rate (66.4 percent). It was also the most expensive election in the history of independent India. But most importantly, the Bharatiya Janata Party emerged as the single largest party to get a majority in the Lok Sabha (lower house). Narendra Modi, who led the party during the election and is considered to be the biggest reason for the historic won, has been sworn in as India’s prime minister.
The single-party majority has set the foundation for a stable central government for the next five years. Political stability has significantly reduced downside risks to the economy. However, big challenges lie ahead for the new government.
The latest release of GDP numbers reveals that the economy expanded 4.6 percent year over year in Q4 of FY 2013–14 and at an annual growth of 4.7 percent in FY 2013–14. This is the second consecutive year the economy grew at a pace below 5 percent in the last decade. GDP annual growth in FY 2012–13 was a decade low of 4.5 percent (figure 1).
Consumers are deeply concerned about persistently rising prices, especially of food articles. Although inflation has been trending down, as seen in the past four months, upward pressure on wholesale price inflation is still high, and consumer price inflation (industrial worker) has been hovering around 7 percent year over year (figure 2). Consumer prices are still above the target range of the Reserve Bank of India (RBI).
In addition to high inflation, India suffers from poor infrastructure, which impacts most people’s daily lives. The investment cycle has suffered from policy paralysis and structural bottlenecks, resulting in poor job growth. This lack of growth, together with a skill mismatch, created high unemployment and low wage growth. Other major concerns include safety and health care.

Initial policy moves

The journey toward a robust economy will not be easy. The government has acknowledged the challenges and has already started making some bold decisions to improve the country’s economy ahead of the commencement of the Indian parliament’s budget session.
Modi unveiled his top 10 policy priorities within two weeks of becoming prime minister—seeking to unblock an investment logjam and setting deadlines for action in order to revive the economy. His agenda has emphasized three issues: efficient governance, delivery, and implementation.
The aim is to revive the decision-making process with a clear vision and empower government departments to make quick, efficient, and transparent decisions. Good governance will likely add certainty to policy direction, which will remove impediments to higher growth. Processes and procedures will likely improve so that there is “maximum governance with minimum government.”
The agenda also includes improving infrastructure components such as education, health care, water supply, and roads. The 10-point vision has emphasized increasing investment, completing infrastructure projects in a time-bound manner, and efficiently utilizing natural resources. These much-needed infrastructure and investment reforms will likely help revive the investment cycle and boost investor confidence.
Fighting inflation is one of the government’s top priorities. Recently, the new government imposed export restrictions on certain farm commodities and ordered a crackdown on food hoarding to control rising food prices. The government also plans to release additional rice stock in the market to prevent inflationary expectations from building. However, containing prices that have been persistently high for the last few years will not be an easy task.
High inflation has been an outcome of structural deficiencies in the economy. Shortages of warehouse facilities, high dependence on monsoon rains, and a complex network of middlemen have resulted in irregular vegetable supply, leading to price volatility. In addition, external uncertainties, such as the Iraq crisis, are expected to spike crude oil prices, and the predicted lower-than-average rainfall this monsoon may stymie the government’s efforts to contain the upward spiral of prices. The government will likely increase efforts to check structural factors in order to contain prices. All eyes are on the budget that is expected in July 2014.

Focus on fiscal prudence

The previous government significantly deviated from the fiscal target mandated by the Fiscal Responsibility and Budget Management Act. Populist policies and high subsidies caused the gross fiscal deficit to spiral up from 1.27 trillion Indian rupees (2.5 percent of GDP) in FY 2007–08 to around 5.25 trillion rupees (4.6 percent of GDP) in FY 2013–14 (figure 3).1 The rising deficit has been a cause of worry among investors, which implies that fiscal consolidation will not be an option going forward. As a first step to restore the country’s financial discipline and “self-confidence,” the government has announced a hike in railway fares and freight charges to improve railway finances and reduce subsidies. In addition, the government has proposed the divestment of public sector undertakings. It will likely suggest other prudent measures to check the fiscal balance without compromising on kick-starting investments in infrastructure.

Policy actions that may follow

Growth in the agricultural sector spurred India’s economy this year. However, both manufacturing and mining industries contracted in FY 2013–14, while the construction sector performed poorly due to lackluster infrastructure. Growth in consumer durables (which represent overall consumer demand) and capital goods (which represent investment demand) have been mostly negative in the last year; the former has been contracting since December 2012 (figure 4).


Industrialists from different sectors have voiced their demands, especially relating to substantial reforms and clarity around policy making. Transparent and business-friendly tax policies and regulations, interest rate rationalization, infrastructure development, transparency and accountability in governance, and, last but not least, effective policy implementation are the core demands from the business fraternity. These parameters will decide the ease of doing business in India, which, according to the World Economic Forum, has a poor ranking relative to other countries.2
The government will likely focus on reviving the manufacturing sector, which has slipped into a recession primarily due to structural bottlenecks and policy paralysis. Most likely, the government will prioritize clearing pending projects by putting them on a fast-track mode and reviving investor sentiments. The central government may work closely with state governments to tackle issues such as land acquisition and tariffs in the power structure, which are the biggest impediments to projects. Structural reforms, such as rolling out goods and services tax, and infrastructure improvement for industries may be other steps to boost the investment cycle in the economy. Reviving special economic zones, discussing issues related to free-trade agreements, and relaxing rigid labor laws will likely be part of policy making to boost manufacturing.
A turnaround in the manufacturing sector will likely help generate growth in GDP and employment. The reversal of investment in the economy and effective implementation of policies will likely boost growth and help contain the price rise.
The new government has created strong expectations of an investor-friendly environment. Foreign institutional investors are already bullish about India, as evident from the reversal of capital inflows into the economy, relative to previous quarters, before and after the election. Stock prices, too, have shot up 18 percent since the beginning of this year (figure 5). However, it is foreign direct investment (FDI) that requires more attention to ensure a sustained source of capital investment. In order to boost investment, the government is taking measures to improve FDI in various sectors that require huge capital investment. The government has already circulated a cabinet note allowing 100 percent FDI in the defense sector. The Commerce and Industry Ministry now aims to relax foreign investment norms in the railway sector by permitting 100 percent FDI in high-speed train systems and dedicated freight lines. The department is also looking at all the possible areas in railways where FDI can be permitted in order to encourage the sector’s growth. The railway sector is critical to driving India’s economic growth through direct and indirect economic linkages; substantial investment through FDI to modernize and upgrade this sector has the potential to raise GDP significantly.
All eyes will be on the budget that will be presented at the end of July, which will give more clarity to policy initiatives and the direction of the new government.

Role of monetary policy

The external sector has continued to improve; the current account deficit narrowed to 0.3 percent in Q4 of FY 2013–14 (figure 6). Imports declined sharply, primarily due to a steep drop in gold imports. The currency appreciated, too, due to strong capital inflows. The external sector is currently not a concern for the RBI, though it may continue to impose restrictions on gold imports.
On the other hand, consumer prices are still above the RBI’s target range. As a result, despite the fall, the RBI decided to keep the policy rates unchanged in its second bimonthly monetary policy meeting because there is room for inflation rates to come down on a sustainable basis.However, the statutory liquidity ratio of scheduled commercial banks was cut by 50 basis points, which will likely improve bank lending to investments. In other words, the RBI governor has signaled that growth will likely not suffer on account of lack of liquidity, though he will keep a close watch on inflation.
In the coming months, the monsoon will play a crucial role in calibrating monetary policy. The monsoon is predicted to be lower than average, which will likely have implications for both inflation and growth. Moreover, if global uncertainties such as the Iraq crisis intensify, the rise in global fuel prices could make domestic inflation rise. The RBI will closely monitor economic conditions and will likely undertake corrections and adjustments accordingly. However, it will be a tough balancing act for the RBI. If the current economic scenario is viewed dispassionately, India needs more than just monetary policy to correct its course. There has to be more action to manage the fiscal account and address structural deficiencies, and monetary policy alone cannot turn the tide.


1. Ministry of Finance, Department of Economic Affairs, Indian public finance statistics 2012–2013, July.
2. Klaus Schwab, The global competitiveness report, 2013-14 (full data edition), World Economic Forum.
3. Raghuram G. Rajan, “Second bi-monthly monetary policy statement, 2014-15,” Reserve Bank of India, June 3, 2014.