Modi 3.0: NDA's return promises policy continuity, but a stronger Opposition can shape Modi's economic agenda

“The most important economic reforms of 1991 were carried out by a coalition government,” says veteran economist M. Govinda Rao, Professor Emeritus at the National Institute of Public Finance and Policy (NIPFP), who was a member of the 14th Finance Commission. “Necessity was the mother of invention. The country had no choice at the time but to go through with these economic reforms,” says Rao, also the Chief Economic Adviser at Brickwork Ratings, underlining that coalition governments are not bad news for economic policymaking.

He, however, cautions that the Modi 3.0 government may work on reforms at the margin but big-ticket ones relating to land and labour may not go through. “It is unlikely that they will have enough support for carrying out such major reforms,” he says.

This view is shared by most policy watchers and experts, who believe that the fast and decisive pace of reforms, which was a hallmark of the first two terms under Prime Minister Modi, may slow down as the NDA government will have to discuss many issues and accommodate the priorities of its two largest allies—the N. Chandrababu Naidu-led Telugu Desam Party (TDP) and the Nitish Kumar-led Janata Dal (United) or JD(U).

“Coalition partners will gain influence and leverage in policy decisions, allowing for a more inclusive approach to governance… the BJP will need to use the tools of negotiation and compromise to maintain a cohesive government. This will likely slow decision-making and potentially dilute some of the party’s key policy initiatives,” Aditi Raman, Associate Economist at Moody’s Analytics, writes in a note.

Government officials, who have worked behind the scenes during the Model Code of Conduct to prepare the 100-day agenda for administrative ministries, are on wait-and-watch mode and believe that at least some of the reform plans would continue unhindered.

There is a general consensus, however, that Modinomics 3.0 will have broad policy continuity and will continue to prioritise segments such as capital expenditure and infrastructure development, boosting investments in manufacturing, fiscal consolidation, as well as measures to improve the ease of doing business, that is expected to help sustain the revival in private investments. This is evident from the BJP retaining many of the key Cabinet portfolios despite having 72 ministers in the Council of Ministers. Nirmala Sitharaman taking charge as Finance Minister is also seen as a sign of continuity and she will present her seventh Union Budget in a matter of weeks.

“The focus of the new government will continue to be on growth, employment and welfare measures. We expect sustaining the growth momentum to be the top agenda for the government and the focus will be not only on public sector capital expenditure-driven investments, but also on boosting private sector investments through measures such as PLI,” says Suman Chowdhury, Chief Economist and Head of Research at Acuité Ratings & Research.

According to him, incentives in sectors such as electronics, new technology, renewable energy and defence may be modified further to attract more investments. “Private sector investments can also create jobs. Unemployment was a major issue in the elections and the government will now work on this. It could also announce more incentives for sectors such as construction that are doing well and generate more jobs,” he says.

For now, the economy is in good shape with the Reserve Bank of India projecting real GDP growth at 7.2% in FY25, which would make this the fourth consecutive year of over 7% growth. The fiscal deficit has also been under control, improving to 5.6% of the GDP in FY24, against the Revised Estimate of 5.8%. Tax collections have remained robust and have exceeded the Revised Estimate for FY24 and high frequency indicators point towards continued buoyancy in the Centre’s tax collections.

UBS Securities has, in fact, highlighted that the Indian economy is in a Goldilocks phase with strong growth and manageable macro stability risks. “We believe India is on track to achieve 6.5-7% year-on-year growth in the medium-term,” says Tanvee Gupta Jain, Chief India Economist at UBS.

All this gives the new government the comfort and the opportunity to set out fresh priorities, take some new risks and tackle existing challenges. Expectations are that the Union Budget 2024-25, which is set to be presented in July, will take up many of these issues and set out on a possible course correction while continuing with the overall policy stance.

On the anvil is a possible tweak in the PLI scheme that could boost private investment in manufacturing and create jobs, a focus on welfare and populist schemes, continued prioritising of fiscal consolidation and capital expenditure, and higher allocations for schemes such as the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) that could put more money in the hands of rural households.

But first, the new government will have to deal with existing challenges. For instance, spurring growth in India’s manufacturing sector, which could lead to more jobs being created and revive private investment. At present, the sector contributes around 17% to the GDP, though the government has been keen on increasing the number to 25%. Past measures such as the Make in India scheme, Atmanirbhar Bharat, PLI, and a cut in corporate taxes have brought in mixed results and much more needs to be done, say experts. They add that the services sector alone is not sufficient to generate jobs for India’s workforce that sees 4 million entrants every year.

Boosting private investment after the pandemic has been a challenge, though some data has pointed to a nascent revival in recent months. It is yet to be seen to what extent companies will turn cautious after the poll verdict, but the hope is that the continued political stability would give them some comfort.

The lack of jobs seems to have been a burning issue among voters, and some reports have highlighted that the spectre of jobless growth continues to haunt the economy. Official unemployment data from the Periodic Labour Force Survey reveals that the unemployment rate for persons aged 15 years or above had declined to 3.1% in 2023, from 3.6% in 2022 and 4.2% in 2021. But, a closer reading of the numbers indicates that unemployment continues to be a problem, especially for graduates.

The India Employment Report 2024 prepared by the Institute for Human Development and the International Labour Organization had highlighted that in 2022, the share of unemployed youth in the total unemployed population was 82.9%. “Unemployment cannot go away at one go and will take time. A lot needs to be done, including labour reforms,” says NIPFP’s Rao, noting that 75% of workers are employed in units with less than 20 workers. “We need to move into medium- and large-sized industries. Skilling and education also have to be improved,” he adds.

Rising prices—with retail inflation remaining close to 5% while inflation in food items (including vegetables and cereals) is even higher at 7%—have also pinched household budgets; this has also muted their discretionary spends to an extent. Private consumption demand, too, has been muted and the Budget is expected to have at least some sops to lift household spends.

In fact, expectations are that RBI’s Rs 2.11 lakh crore bumper dividend to the government could be used for some populist schemes to put more money in the hands of the people. While the middle class is hoping for some tax cuts to help them offset the impact of higher inflation, schemes such as the Pradhan Mantri Kisan Samman Nidhi could also see an increase in the annual disbursement from the current Rs 6,000 per year. Sops for women in the form of a welfare scheme could also be unveiled.

One of the first decisions by the Cabinet after its formation was to provide financial assistance to 30 million additional rural and urban households for the construction of houses under the Pradhan Mantri Awas Yojana. Chowdhury of Acuité Ratings expects an increase in the allocation to welfare programmes, pointing out that till now, this has been moderate compared to what the Opposition has promised.

“The Budget may increase allocation to schemes such as PM-Kisan as well as on the food subsidy to offset rising prices. This, however, may not have much impact on the fiscal deficit given that the government has a windfall from the RBI dividend,” he notes.

Jain of UBS feels that the higher-than-expected dividend (additional 0.3% of GDP in FY25) would create fiscal leeway to increase populist spending to support consumption for the lower-income strata (cash transfers, higher rural spending, income tax rationalisation, affordable housing) while continuing its thrust to boost public capex. “Our base case is for the government to stick to a medium-term fiscal consolidation road map but with a populist bias,” she said at a recent webinar.

A tweak in the National Pension System for central government employees is also hoped for and expectations are that the government will announce some relaxation in the current defined benefit scheme. The Modi-led government in its second term had set up a panel under Finance Secretary T.V. Somanathan in March 2023 to review the scheme and its interim report is understood to have been submitted.

Other pressing issues are asset monetisation and strategic disinvestment. The way forward remains unclear and could to some extent be guided by the priorities of the government’s new allies. But an aggressive stance is unlikely. The Interim Budget had kept a conservative target of Rs 50,000 crore from disinvestment in FY25 and a few strategic stake sales, including in IDBI Bank and Shipping Corporation of India, are underway. It is expected that these will continue, depending on the interest from investors. The government is also looking to sell off assets of Bharat Sanchar Nigam Ltd (BSNL) and Mahanagar Telephone Nigam Ltd (MTNL), which own a large amount of real estate. “There is an identified pool of assets that can be taken up for complete privatisation. The decision will have to be taken by the government on how it wants to proceed,” say sources, adding that there could be issues with the sell-off of units in certain states that allies may not like.

But further stake sales and strategic sales may not be so easy, especially plans for privatisation of public sector banks and a few insurance companies. “Any unpopular move will be avoided clearly for the near term due to a reduced mandate,” Suresh Ganapathy, Managing Director and Head of Financial Services Research at Macquarie Capital, writes in a recent note.

T he most important move under the new coalition government is likely special financial packages for Andhra Pradesh and Bihar. New coalition partners TDP and JD(U) have for long been demanding special category status for Andhra Pradesh and Bihar, respectively. Experts point out that the definition of special category status may have to be tweaked as there is no Planning Commission that used to decide on the Plan expenditure and a financial package may be an easier solution.

Bihar Chief Minister Kumar had in 2005—when he was first sworn in as the state’s CM—called for special category status, contending that the state remains backward and under-developed. He reiterated this demand last November. Naidu, too, has been campaigning for special category status for Andhra Pradesh as the bifurcation of the state led to a loss of revenue, with Hyderabad, the capital of the unified state, becoming a part of Telangana. Naidu, who is the new Andhra Pradesh CM, is also hoping to revive a shelved plan to reinstate Amaravati as the state capital, which would require funds.

Rao points out that the tag of special category status was earlier given by the National Development Council, which no longer exists. “This can perhaps now be done through a Cabinet resolution,” he says, adding that funds for a special assistance package are given through the Union government’s budgetary allocation and does not require any special fiscal measure. A special assistance package is more likely, he says.

D.K. Srivastava, Chief Policy Advisor at EY India, says special category status was a concept that was relevant as long as the Planning Commission existed as it typically applied to Plan Assistance. “The concept of Plan Assistance is not there anymore. By special category status, states are asking for a special assistance package,” he says, adding that this will have to be designed by a government body such as the NITI Aayog or the finance ministry, depending on the requirements of the state.

A special category status enabled Plan Assistance as 90% grant compared to 30% grant for other states. In centrally sponsored schemes, these states also receive 90% grant from the Centre as compared to 60% in the case of other states. As much as 30% of the Union expenditure is also incurred in these states. Funds to these states also don’t lapse at the end of the fiscal.

But Rao warns that giving this status to Bihar and Andhra Pradesh will open a Pandora’s box. “While Bihar has the lowest per capita income in the country, Uttar Pradesh has the second lowest, and it will also seek a similar dispensation. Other states like Jharkhand, Chhattisgarh, Rajasthan and Madhya Pradesh will also not be far behind in asking for a similar benefit,” he says.

Clearly, this could impact the Centre’s carefully planned fiscal consolidation road map that aims to attain a level of fiscal deficit lower than 4.5% of GDP by FY26. But for now, there are many factors at play and several issues to be discussed. How the Narendra Modi 3.0 government takes them forward in the coming weeks and months could set the ball rolling for the next five years.

@surabhi_prasad