Devangshu Datta: Raining on animal spirits

Uncertain monsoons and the economic forecast from other countries could affect the NDA government's effort to revive the economy

Is he lucky?" Napoleon Bonaparte is said to have asked that question before appointing a new general. The story is probably apocryphal. But it underlines the role played by that elusive quality of luck in any major venture.

The question would be equally apposite if asked about a politician or a government. The first phase of India's liberalisation between 1991-1996 was accompanied by excellent luck in the form of several good monsoons in succession. In contrast, the National Democratic Alliance suffered through the vagaries of droughts and earthquakes during the Atal Bihari Vajpayee regime.

The new government may well be wondering if luck will run in its favour as it tries to revive the animal spirits in an economy, which has been in stagflationary mode for over two years. The monsoon is playing hide-and-seek and the latest El Nino-related news is not good.

Rainfall predictions were cut last week - the monsoon will be below normal, given a 70 per cent probability of El Nino patterns. A poor monsoon would lead to inflationary pressures on the food front. Since food has a huge weight (about 48 per cent) in the consumer price index (CPI), it would push retail inflation up. That would mean the Reserve Bank of India (RBI) refusing to cut policy rates.

An additional worry has also become apparent. There is a crisis blowing up in Iraq as the Islamic State in Iraq and the Levant hardliners make a push into that unfortunate country. This has already pushed international crude prices up to nine-month highs. If the price uptrend is sustained, it could have nasty implications for India. It could force the new government to choose between higher inflation if it rationalises energy prices, or accepting a higher subsidy bill and, therefore, a bigger fiscal deficit.

The latest inflation and growth numbers, which were released last week, are favourable, however, and those beat consensus expectations. The CPI rose 8.28 per cent for May 2014 versus May 2013 - this is better than the 8.59 per cent recorded in April 2014. The Index of Industrial Production (IIP) was up 3.4 per cent in April 2014, versus April 2013. That is a big turnaround given negative IIP returns in March 2014. IIP is notoriously difficult to "deseasonalise" however so, we'd need to see if this sustains.

Exports bounced sharply as well, with double-digit growth seen in May and nine per cent growth in April-May versus April-May 2013. The trade deficit also rose, mainly due to rising oil imports, though it is not at alarming proportions.

The macroeconomic data do suggest some recovery in the offing for India but it may not be a huge bounce. In its latest policy review, the RBI maintained growth expectations of gross domestic product (GDP) growth between five and six per cent for 2014-15. The World Bank has cut India's GDP expectations to 5.5 per cent, from its earlier (January 2014) prediction of 6.2 per cent.

In fact, the World Bank has cut its global GDP growth forecast to 2.8 per cent, from an earlier 3.2 per cent. Among individual nations, the GDP forecasts for the US, Russia, China and Brazil have also been lowered. Ukraine deserves special mention since that unfortunate nation is likely to see massive economic contraction. An escalation of tensions there could translate into higher gas prices.

The US itself has reviewed its Q1 (January-March 2014) GDP estimates down sharply. The American economy is believed to have contracted by up to two per cent, in what is reckoned to be among the worst quarters it has ever experienced. The terrible weather was partially responsible.

Despite this contraction, the US Fed seems determined to continue tapering. The Japanese have apparently started considering cutting back on the Abenomics quantitative expansion. The European Central Bank will probably loosen up. Net-net, overseas borrowing costs could rise for emerging economies, including India, over the next year to two years.

The Budget will have to pay due heed to all these factors. It is among the most eagerly awaited documents in recent memory and the focus has been on this since Parliament opened and the president announced the new government's agenda.

There are multiple rumours about likely budgetary provisions: A new timeline for the Goods and Services Tax implementation; raising exemption limits in income tax; cuts in excise rates and what have you. The Bharatiya Janata Party fought the most heavily-funded election campaign ever and much of that funding came from corporate sources, in India and abroad. These amount to IOUs that the Narendra Modi government must repay with interest. The best way it can do so is to establish a business-friendly environment.

Arun Jaitley has this one chance to come clean about the state of government finances. He must also deal with the legacy of the sweeping changes his predecessor made to ministry allocations in the last budget. He will have to find ways of controlling deficits, stimulating growth and convey the impression of a government that adheres to consistent policy-making driven by common sense. He will also have to avoid accusations of crony capitalism.

More broadly, the Modi government will have to find ways to revive investments into infrastructure without running foul of the new land laws (which it voted for while in Opposition). It will also have to review and accelerate norms for environmental clearances. Targeting NGOs via absurd leaked reports may not be the optimal method of doing this.

The stock market reacted on Friday as fears about Iraq surfaced. The rupee also dipped. Major indices had hit unprecedented levels of Nifty 7,700 before the sell-off. Forex reserves have risen through the post-election period as foreign institutional investors buying has driven the Nifty up six per cent in the last three weeks. Domestic institutional investors (DIIs) are still net sellers. The next big uptrend could be dependent on a change in DII attitude.