Inflation still a challenge for Modi: ANZ Research

The lack of ‘big bang’ reforms initiated by the new Modi government in India means the price of food and other goods is unlikely to come down. Without a majority in the upper house of the Indian parliament, the government is only able to deal only with ‘low hanging fruit’, and even then, these smaller scale reforms will take time to progress. More significant issues such as food supply and distribution will have to wait.

Ideally, ANZ Research believes the government could move to open up the coal sector to private businesses and deregulate the sale of urea. Urea is perhaps the most symbolic of the reform problems inherited by Modi. Heavily distorted fertiliser prices have contributed to inefficient use, making food inflation all the more difficult to tackle.  Instead, the small changes available are limited to improvements in land acquisition laws, goods and services tax implementation and the removal of some foreign direct investment restrictions. These will still require the approval of the upper house but are less controversial.

"The new government has installed greater business confidence with power production and investment spending increasing significantly."
Devika Mehndiratta, Senior Economist, ANZ

As a result, inflation in 2015 is likely to rest above 7 per cent in the second half of the year, well above the Reserve Bank of India’s target of 6 per cent for the commencement of 2016. The previously high levels of inflation have been hurting consumer confidence, with rates above 10 per cent over the past 3 years placing pressure on incomes. This pressure is likely to resume come 2016.

India’s economy is nevertheless making a gradual recovery.

In the immediate term, a weaker than usual monsoon has positively affected food prices for consumers and a fall in the price of crude oil will see inflation come down to around 6 per cent in October/November from the current 7.8 per cent.

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The new government has installed greater business confidence with power production and investment spending increasing significantly in recent months. Growth in GDP is expected to be strong this year and reach 6.2 per cent in 2015. This growth, combined with an expected increase in tax take and the impending elimination of the diesel subsidy, should see the fiscal deficit decline over the next two years.

More could be done on this front, however. The recently released budget relied too heavily on divestments rather than tackling the nebulous food and energy subsidies which must be reduced if funds are going to be freed up for significant outlays on needed infrastructure – particularly roads and electricity.  However, given it was handed down just a few months after taking office combined with the complexity of subsidy reform, we remain confident that the second budget in 2015 will make a more meaningful impact.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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