The new government must address supply-side bottlenecks on priority over demand-side factors to accelerate and sustain the pace of GDP growth-Ind-Ra

Challenges for the New Government

Reviving the economy and pushing gross domestic product (GDP) growth without stoking inflationary pressure are the main challenges before the new government, says India Ratings & Research (Ind-Ra). The new government must address supply-side bottlenecks on priority over demand-side factors to accelerate and sustain the pace of GDP growth. Clearly, this would require active policy support.

Ind-Ra believes the new government must curb inflation on priority through a multipronged strategy. While the Reserve Bank of India (RBI) is pursuing a tight monetary policy to tame inflation, the government will have to formulate a new agricultural policy to address the prevailing stubborn food inflation. This policy must effectively address the changing food consumption patterns of Indian households and accordingly incentivise the crop mix and its production.

Besides controlling inflation, Ind-Ra believes reviving investment is critical to stimulate GDP growth. The new government can kick start the stalled investment cycle by resolving some of the vexed tax issues such as retrospective taxation/tax disputes and establishing better coordination with states.

The new government must focus on accelerating manufacturing growth by reducing infrastructure deficit. Growth can also be pushed by facilitating foreign direct investment, addressing the financial/technological issues confronting micro, medium and small enterprises, providing training to the labour force and creating a common pan India market by introducing the goods and services tax (GST).

We believe the new government must continue with the process of fiscal correction in the FY15 Budget. Many developed economies have a fiscal deficit/GDP ratio much higher than that of India (rated 'BBB-'/Stable by Fitch Ratings). However, India's debt/revenue ratio is much higher than that of other Fitch 'BBB' rated economies due to a smaller revenue base. This makes India's public finance highly vulnerable to growth cycles. In FY14, the country's debt/revenue was 3.1x compared with the 'BBB' rated peer group's median value of 1.5x. Low revenue base and high committed expenditure are the two major issues confronting Indian public finances. To achieve debt/revenue similar to the 'BBB' peer group's median, India will have to at least double its revenue given its debt level.

Besides enhancing tax compliance and reducing tax disputes, Ind-Ra believes the best way to augment tax revenue is to implement the direct tax code (DTC) and the GST at the earliest. Selling government stake in public sector undertakings (PSUs) is often considered to be an important source of non-tax revenue. However, we believe this is not the right time to undertake disinvestment. The price/earnings ratio of BSE Sensex and BSE PSU Index indicates that disinvestment in PSUs at the current juncture will not fetch handsome returns to the government due to lower valuation.

The new government must push the pending financial sector reforms and further strengthen the regulation, supervision and risk management practices in the sector. Ind-Ra believes public sector banks (PSBs) would need an INR6.8trn capital infusion by FY19 to meet the capital adequacy ratio norms of Basel III.

Also, the PSBs are currently facing the heat from rising bad debt. Though there has been some improvement in India's insolvency regime over the past two decades and legal measures are yielding results, there is a need to further strengthen this process by setting up a national asset management company to take over large bad loans. This, however, should be established after ensuring that banks do not take undue advantage of this mechanism to clean up their balance sheet.

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