Modi 3.0 will have policy continuity amid fiscal challenges: Moody's

The Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) secured a majority in the general elections, securing a third term for Prime Minister Narendra Modi.

This victory indicates continuity in policy, particularly in infrastructure spending and boosting domestic manufacturing, which are expected to support robust economic growth.However, the NDA's slim margin of victory and the BJP's loss of an outright majority in parliament may slow down more extensive economic and fiscal reforms, potentially impeding fiscal consolidation efforts.

In fiscal 2023-24, India's real GDP accelerated to 8.2 per cent from 7.0 per cent the previous year, driven by significant gains in gross fixed capital formation as the government's infrastructure programs gained momentum, even as private consumption remained subdued.

Moody's projects India's economic strength to continue, with an anticipated real GDP growth of around 7 per cent over the three-year period from fiscal 2023-24 to 2025-26. 

This growth is expected to benefit from ongoing infrastructure development and digitalization efforts.

Despite this outlook, structural weaknesses pose risks to long-term growth potential. High youth unemployment and low productivity growth in the agriculture sector constrain economic expansion.

The agricultural sector's modernization has been stalled by political challenges, as evidenced by the repeal of key reforms in 2021 following widespread farmer protests.

Additionally, gains in manufacturing have been uneven, limiting labour force diversification away from agriculture, which still accounts for 40 per cent of total employment.

Foreign direct investment (FDI) inflows have declined over the past three years, despite a favourable geopolitical climate amid US-China tensions.

This trend suggests persistent constraints within India's investment climate. To address these challenges, further structural reforms and enhanced implementation of existing initiatives, such as the production-linked incentive schemes to promote manufacturing, calibrated liberalisation of cross-border trade, and reconsideration of labour reforms, are necessary.

The government's focus on fiscal consolidation is expected to continue, but significant improvements in debt ratios and interest servicing have yet to be realised.Since the trough in fiscal 2020-21, the central government's deficit has likely narrowed for three consecutive years.

The interim budget for fiscal 2024-25 projects a deficit of around 5 per cent of GDP, aiming for a 4.5 per cent deficit by fiscal 2025-26. However, India's fiscal consolidation post-pandemic has not outpaced other emerging markets in Asia-Pacific, and its fiscal and debt metrics remain weaker than those of Indonesia, the Philippines, Thailand, and other Baa-rated peers globally.

India's general government debt is projected to stabilise above 80 per cent of GDP over the next three years, compared to 70.5 per cent in fiscal 2018-19.General government interest payments are forecast to fall to around 24 per cent of general government revenue over the next two years, down from over 28 per cent in fiscal 2020-21, but still higher than the pre-pandemic ratio of less than 23 per cent.

While increased budgetary allocations for infrastructure indicate an improvement in spending quality, debt servicing remains a significant portion of expenditure, reflecting ongoing constraints on fiscal flexibility.

This situation underscores the need for the incoming government to balance fiscal consolidation with growth-supportive measures.

The upcoming final budget for the fiscal year ending March 2025 will provide further insights into India's fiscal policy direction through 2029.

As the Modi administration embarks on its third term, the focus will likely remain on sustaining economic growth while addressing the persistent fiscal challenges that hinder India's long-term economic potential.