While the government is flush with cash this year and deficit targets aren’t at risk, the fiscal concerns lie further down the road, Deveshwar said | Photo: Bloomberg
By Ruchi Bhatia
India’s Prime Minister Narendra Modi has a tough balancing act to manage in the first budget of his new coalition government.
He’s facing billions of dollars in spending demands from two key allies who he’ll need to keep happy to make the coalition work. At the same time, he’s under pressure to curb government debt before credit rating companies will consider any upgrades.
The two allies — regional parties which together hold 9.5 per cent of the governing coalition’s seats in the national parliament — have already put demands on the table for more than $15 billion in financial aid for the states they run.
For now, it seems that Modi will likely be able to manage those demands without blowing out the budget deficit. That’s largely thanks to a record transfer of funds from the central bank and a surge in tax revenues, which have boosted the government’s coffers. Economists surveyed by Bloomberg predict the government will either stick to its deficit target of 5.1 per cent of gross domestic product for the fiscal year through March 2025, or narrow it slightly.
Both the coalition partners didn’t haggle much over powerful positions in the cabinet, which went to top leaders in Modi’s Bharatiya Janata Party. Instead, the two allies — N Chandrababu Naidu of the Telugu Desam Party and Nitish Kumar of the Janata Dal (United) — have used their positions to push for funding for their financially-troubled states.
The TDP has demanded more than $12 billion over the next few years for the southern state of Andhra Pradesh, with a substantial portion to be paid out in this year’s national budget. Naidu recently told his party’s parliamentarians to mobilize as much funds as possible from the government. The JDU is seeking assistance of $3.6 billion this year to help fund projects in the eastern state of Bihar, one of the poorest provinces in the country.
These sorts of budget demands are the “cost of doing business” in nearly all coalition governments, said Milan Vaishnav, director and senior fellow of the South Asia Program at the Carnegie Endowment for International Peace. “The only open question is the precise modality of the transfers.”
Naidu made an impressive comeback last month after winning the state elections and 16 seats in the national parliament. He says his state’s coffers are empty due to “mismanagement of funds” by the previous regional administration. He wants to breathe life into building a new capital Amaravati, complete an irrigation project that’s been delayed for years and find ways to attract investments.
Meanwhile, Kumar, who has a controversial political career as a leader that’s often switched sides, needs to show that he is able to lure more funds to Bihar before crucial elections next year. Outstanding debt in both the states amount to more than a third of their respective gross domestic outputs.
“The political landscape has become more complex for Modi given the need now to negotiate with allies who he has to depend on to stay in power, and who will want to push their own agenda as is evident from their demands,” Shumita Sharma Deveshwar, chief India economist at GlobalData.TS Lombard, said by phone.
Risks Galore
While the government is flush with cash this year and deficit targets aren’t at risk, the fiscal concerns lie further down the road, Deveshwar said.
“The risk with giving into one regional party is increased demand from others and the perception of political favoritism, which won’t go down well with voters in other regions,” she said.
States including Karnataka, West Bengal and Kerala have long complained that they’re not receiving their fair share of tax revenue collected by the federal government and then distributed to the provinces. States have limited ability to raise their own revenue through taxes and can’t borrow more than 3 per cent of their GDP.
India’s ability to curb the deficit and government debt will affect its credit ratings, which are currently the lowest investment grade level. S&P Global Ratings has signaled a possible upgrade in coming months if India’s fiscal metrics improve.
Finance Minister Nirmala Sitharaman had previously pledged to curb the budget deficit to 4.5 per cent of GDP in the fiscal year through March 2026, and that remains an important objective for the government, said Jeremy Zook, a director of Asia Pacific sovereigns at Fitch Ratings Ltd.
Beyond that “we have less clarity on the fiscal path,” he said. “And while we expect gradual deficit reduction to be sustained, realities of coalition politics could mean a slower pace of consolidation over the medium-term.”
The BJP’s worse-than-expected election performance increases the possibility of more welfare spending to shore up voter support before several key states go to the polls over the next 12 months. Sitharaman’s budget speech on July 23 will be closely watched by investors for clues on the coalition government’s spending priorities going forward.
“Even if the government decides to use part of the surplus funds for populist measures, some demands of the allies can certainly be met,” Garima Kapoor, an economist at Elara Securities India Pvt Ltd, said by phone. The government will be able to keep the deficit target intact this year, she said.
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