New Indian Government Announces Economic Reforms to Induce Growth

June 11, 2014 Posted by India Briefing Reading Time: 3 minutes

MUMBAI – Yesterday, India’s Minister of Finance, Arun Jaitley, announced the newly elected government’s general plans for addressing stagnant economic growth and mounting inflation, or stagflation.

At a pre-budget meeting with finance ministers from states and union territories, Jaitley announced his plans to implement the Goods and Services Tax (GST), distribute more fiscal power to individual states, reduce inflation on food prices and increase investment in infrastructure among other initiatives.

Economic growth remains a top priority for the new government. GDP growth in India has declined sharply since 2011, from a high of 10.1 percent in 2011 to 4.4 percent during the first quarter of this year.

Slower economic growth often means higher levels of unemployment, and the demand for jobs is expected to increase as India’s youth bulge enters working age. According to the Diplomat, with India’s current demographic composition, approximately a million people will join the Indian workforce each month until a peak of 653 million workers is reached in 2031. This places significant pressure on the new government to create employment opportunities to accommodate young Indians entering the labor force.

In addition to stagnant economic growth, India has experienced high levels of inflation since 2008, with a 14.97 percent inflation rate in 2009 and 11.17 percent rate in 2012 (a healthy rate of inflation is generally considered to be between 2 and 5 percent).

While the Modi administration’s economic rhetoric has revolved around stimulating economic growth, the Governor of the Reserve Bank of India (RBI), Dr. Raghuram Rajan, is more concerned with curbing inflation. Since raising interest rates after taking office last September, Rajan has emphasized the RBI’s independence and ability to make its own monetary decisions.

“The so-called tradeoff between inflation and growth is a false trade-off in the long run. Elevated levels of inflation erode household budgets and constrict the purchasing power of consumers. This in turn discourages investment and weakens growth,” said Rajan.

Finance Minister Jaitley plans to revive growth by focusing on infrastructure development projects that require input from several key sectors, including cement, steel and power. In order to refocus government efforts on development projects, Jaitley must continue to cut government debt, work closely with the RBI to reform the banking sector and rebuild confidence among foreign investors.

Jaitley is also aiming to lower inflation from the supply side, which would entail government intervention to maintain a certain supply of agriculture products to keep prices stable.

Although interest rates have been kept artificially high by the RBI for months, the National Bank for Agriculture and Rural Development recently lowered its interest rate by 20 basis points for the agriculture sector and additionally promised a 50 basis points reduction for funding innovative agriculture activities such as post-harvest management and precision farming that have the potential to increase agricultural productivity.

“We are committed to breaking this vicious cycle of high inflation and high interest rates,” Jaitley said.

Other problems Jaitley discussed included rising food prices and tax reform, announcing plans to introduce a Goods and Services Tax (GST) to replace indirect taxation by union and state governments on goods and services. According to Jaitley, a GST will make taxation more efficient by unifying and integrating individual state economies. State governments are also set to receive more fiscal power in developing their respective region.

The 2014-2015 fiscal budget is likely to be released in July.

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