Modi 2.0 – Challenge for new govt is to get economy on track

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Published: May 25, 2019 3:22:48 AM

Though the target looks ambitious, if public capex crosses 10% of GDP in three years, it will be a good outcome.

The government should continue its focus on building infrastructure with .4 trillion as target for the ensuing five years as stated in the manifesto.

The re-election of the NDA alliance led by Prime Minister Narendra Modi has put to an end to uncertainty and raised hopes that the economy will pick up momentum. Growth rate, according to the second advance estimates, has slowed down to 7% in FY19 and is likely to slip further to 6.8% in FY20 because of weak rural demand, slowdown in investment and impact of relatively higher borrowing costs. The fall in the investment rate has driven down corporate margins.

Aggregate demand is slowing down as rising rural distress has led to slowdown in private consumption and households have gradually reduced consumption due to insufficient income growth. Volume growth at leading FMCG companies—which derive more than a third of sales from the rural areas—has dropped, as for the first time in five quarters, FMCG major HUL reported single digit (7%) volume growth in the three months to March this year.

The rural demand slowdown is unlikely to reverse immediately because of the fall in farmers’ profitability led by low prices. Slowdown in consumption can also be partly attributed to tighter financial conditions following the credit default in the non-bank finance segment, and the slowdown in global growth led to weaker export income.

Monetary policy support in the form of policy easing and easier liquidity conditions will help to ease financial conditions and positively impact domestic demand. A cyclical recovery in consumption will bode well for capacity utilisation and capex, and give a fillip to manufacturing activities that had contracted in March.

Gross fixed capital formation dropped to 28.6% of GDP in FY18 from an all-time high of 34.3%, as private sector investment remained stagnant at 11% of GDP during the period. Household investment, which accounts for small and medium enterprises, reported a steep fall—from 15.7% of GDP in FY12 to 10.3% in FY18.

Tax collections in FY19 have been lower than the revised estimates, which will strain government finances. Government expenditure may increasingly shift towards compensatory expenditure and away from development expenditure, which may further constrain overall investment in infrastructure.

The Centre should continue to rationalise GST rates, revamp corporate tax rate and lower headline rate to 25% for large corporates, as promised by finance minister Arun Jaitley. The government should continue its focus on building infrastructure with $1.4 trillion as target for the ensuing five years as stated in the manifesto. Though the target looks ambitious, if public capex crosses 10% of GDP in three years, it will be a good outcome.

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