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28 May 2014

India votes for change

Frederic Neumann

by Frederic Neumann

Co-Head of Asian Economic Research, HSBC

India votes for change

We are maintaining our growth forecast of 5.3 per cent for India for 2014-15

The decisive victory in India’s general election for Narendra Modi and the Bharatiya Janata Party gives the new government the political muscle to move forward structural reforms that are desperately needed for a sustained recovery in the country’s growth.

From a macroeconomic perspective, May’s election outcome was positive. Given the Modi-led government’s likely emphasis on enhancing infrastructure, we expect investment projects will be rolled out faster, which will help gradually reduce bottlenecks in the economy.

Structural economic reforms take time to get through the political machinery, even for a government with a strong mandate

However, it is important to be realistic about the pace of political and economic change, at least in the near term. The new government will not be able to change things overnight and the recovery in GDP growth will likely prove protracted, possibly even moving sideways until there is measurable progress on reforms and investment projects.

Structural economic reforms take time to get through the political machinery, even for a government with a strong mandate. For example, the pending reforms of direct tax and the goods and services tax still have to be finalised and find broader political support. In the latter case, state government consent is also needed, adding another political dimension to the mix.

In addition, it can take several years before structural reforms have an impact on growth. Education reforms are one example but even steps to deregulate sectors and open the economy will stimulate growth only with a significant lag.

However, on the administrative front there should be scope to move things forward faster. Stepping up efforts to roll out infrastructure investment projects should provide a lift to the investment cycle, though visible signs of that are unlikely before the autumn.

Even so, progress here will likely prove gradual rather than rapid. While administrative improvements will help eventually to speed up progress, it will still take time to get all the necessary approvals and acquire land. Many investment projects are stuck at the state level, which the new government at the centre may be unable to do much about.

While the election outcome helps move things forward, it is important not to overestimate its potential impact on the real economy in the short term, given the time it will take to implement the necessary economic reforms and execute investment projects. Consequently, we are maintaining our growth forecast of 5.3 per cent for 2014-15.

However, it is also important not to underestimate the potential macro impact over the medium term. If the new government can put in place key economic reforms over the next couple of years and begin to address infrastructure gaps that will have significant implications for growth over that period. Growth could reach around 7 per cent by 2016-17.

It will also be important for the government to demonstrate that it is committed to macroeconomic stability. That means presenting a budget that targets continued fiscal consolidation based on realistic assumptions.

Furthermore, it is critical that the Reserve Bank of India is allowed to operate independently and focus on anchoring inflation expectations. Bringing down inflation in coming years will ultimately support investment and growth.

This research was first published on 16 May 2014.
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