Indian budget tackles certain risks to growth

However, considerable downside threats remain unresolved.

The Indian economy is one of the few bright spots in the world in terms of growth. Gross domestic product expanded at a rate of 7.3 per cent in 2015, a slight acceleration compared to 2014's figure and is expected to see faster growth this year.
The International Monetary Fund (IMF), for instance, forecasted growth rates of 7.3 per cent and 7.5 per cent in fiscal years (FY, the period from April to March) 2015-16 and 2016-17 respectively.
The recent Indian budget implicitly assumes a slightly higher growth, at around 7.3 per cent and 7.7 per cent, according to our estimates based on the government's nominal numbers. Indian growth will accelerate timidly in real terms over the next quarters, led by consumption and investment, outperforming most emerging economies. However, there are some downside risks. The three main factors that could derail growth are price instability, loss of investment momentum and vulnerabilities in banks' balance sheets.
Inflation seems under control, but the latest improvements rely on low food inflation and energy prices. Adverse weather effects and a pick up in oil prices - which is entirely imported - could revive inflationary pressures, forcing the central bank to increase policy rates and the government to spend more on subsidies.
The political stalemate, which is blocking essential reforms, could also harm growth, as investors could lose confidence on the implementation of reforms. In the past years, net foreign investment grew along with the economy, from Rs1,108 billion in 2011 to Rs2,112 billion in the last four quarters. Losing reforms momentum could hurt FDI and economic activity.
Banks' asset quality
Finally, the IMF also warned about asset quality and low capital ratios of state-owned Indian banks, which might result in insufficient quality lending and financial instability.
The budget for FY 2016-17 addresses these potential risks to some extent. The focus on the rural sector is not only intended to improve the livelihood of economically depressed areas, but also to secure food supply and control prices. Projects such as irrigation systems, food storage facilities and rural road networks are detailed in the developments plans, and could have a positive impact on price stability.
Beyond rural issues, energy (29.2 per cent) and communications (34.5 per cent) still represent the bulk of the budget. Spending in investment in these areas will contribute to raise investor confidence.
Moreover, the budget includes an allocation of Rs250 billion (11 per cent of commercial bank assets) for public banks to strengthen their balance sheets. The government also stressed the commitment of listing public companies in the stock exchange, which could provide additional capital and improve corporate governance.
Downside risks remain considerable, but the budget contributes to reduce them somewhat. However, its release did not come free of criticism.
Over-optimistic assumptions
The assumptions behind the budget, particularly nominal GDP growth (10.8 per cent) and oil prices ($42 per barrel) have been regarded as over-optimistic. Lower growth would imply lower revenue from taxes and an automatic increase of the deficit. Higher oil prices would increase the political costs of introducing new taxation on gasoline and diesel, and increase the energy subsidy bill.
If these assumptions do not materialise, the reduction of India's deficit from 3.9 per cent to 3.5 per cent of GDP will prove elusive, and fiscal sustainability, in spite of not representing an immediate threat, will worsen.
Overall, the budget addresses India's main needs and concentrates on preventing some of its main threats from materialising.
The writer is an economist at Asiya Investments Company. Views expressed are his own and do not reflect the newspaper's policies.

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