Modi’s operandi: a few steps forward but where’s India’s budget going?

The election win of Indian prime minister Narendra Modi earlier this year brought hopes of an economic revival for the country. Yet, while the new government’s first budget, handed down in early July, aims for higher growth, employment, better amenities, infrastructure and governance, how the new budget measures are expected to achieve these aims is unclear. There is some alignment between the overall strategy and the rhetoric, but the various measures are not integrated well enough to tell a coherent story, and the changes announced are not quantitatively significant.

India’s economy has long suffered from government mismanagement. External shocks aside, India’s high inflation and low growth are the result of government expenditure that increased demand for a variety of foodstuffs while, at the same time, continued agricultural restrictions prevented an appropriate supply-side response. Poor governance burdened the Indian economy with high transaction costs and discouraged private investment and activity. To fix this, the share of capacity-creating government expenditure has to rise even as restraints are removed.

Despite overall continuity with previous economic settings, the budget does nudge towards resolving some key economic issues that have manifested in recent years. Steps toward raising various types of investment and improving investment financing should reinforce each other to raise growth and jobs. The focus on labour-intensive sectors — including infrastructure and housing — on agricultural marketing, rural power, roads, and irrigation, and changes in the composition of public spending will additionally relieve sectoral bottlenecks. Small reforms to the tax system and public services will also encourage activity.

While disappointing, the reform timidity on display in the budget may not detract from the overall change in the direction of India’s economy for two key reasons. First, the Bharatiya Janata Party (BJP) administration is planning to spend more than the previous United Progressive Alliance (UPA) government, especially on capital expenditure, even while it retains transfer payments to weaker sections and the deficit targets. Underlying the latter are optimistic revenue projections. These projections reflect a revival of domestic optimism and international growth. Oil prices have softened, and a stronger rupee and the built-in automatic rise in diesel prices will reduce fuel subsidies. More resources can also be raised from sale of shares in public sector enterprises because of a booming domestic stock market.

But this can only happen if old and unproductive strategies, such as cutting investment to meet deficit targets, are given up.

Better implementation reduces the risks of such strategies. Implementation is supposed to be a forte of the new government, but it cannot be taken for granted, and requires focused attention. Promise-based indices used to rank post-reform Indian governments by how far they deviate from election promises place the earlier BJP coalition government behind both the first Congress and the first UPA government in terms of its ability to keep its budget commitments. The BJP has another opportunity to deliver, but to improve its ranking it must do better this time around.

Second, spending needs to be reallocated across sectors, but this process  began with the interim budget of the last government, which placed an emphasis on infrastructure, housing, water, and de-emphasised social services. So despite the continuity the BJP has maintained the necessary reallocation will take place. The BJP also plans to spend significantly more on water resources and labour-intensive industrial sectors, such as textiles, tourism and construction.

Modi is actually increasing allocations for the social sector relative to the UPA’s interim budget, even raising subsidies at the margin. Spending on social services is essential, but the strains such spending created in the past can be avoided by restructuring towards capacity-creating spending. The BJP is aiming for this, for example, by refocusing spending on rural employment insurance more towards asset creation. A committee has also been set up for rationalising subsidies and reducing other expenditure.

However, there has as yet been no serious attempt to rationalise schemes and ministries in order to increase efficiency and save costs. Instead many new schemes have been announced with some initial seed capital attached. Although the BJP government has fewer ministers at 45 compared to 71 in the UPA II, budget allocations were made for only one less ministry.

While the reforms in Modi’s first budget do not go far enough, it could be an acceptable starting point if the direction were clear. That is why the lack of clarity on policy direction is worrying. For the first time in a long time, India has a majority government, which, at the beginning of its term, has great freedom to act. A reluctance to implement significant change would be a dangerous misreading of an aspirational election mandate.

Ashima Goyal is Professor of Economics at the Indira Gandhi Institute for Development Research.