The first move: The process begins in September with a voluminous circular to all ministries, departments, and autonomous bodies. They reply with details of funds they need the following fiscal year — be it for special projects or routine expenses. These are distilled to form the contours of the budget.
Prime Minister Narendra Modi had said recently that India will need to take bitter pills to come out of the economic mess, making it clear that he was ready to take unpopular steps to improve the economy.
The first of these pills was in the form of a steep railway passenger fare hike (14.2%). Freight rates were also hiked by 6.5% — which could have an impact on inflation.
Read: Govt hikes rail fares by 14.2% with effect from June 25
The reason given was railways is running into losses and hence has to make up. The argument is bizarre. Losses due to poor management can't be compensated by consumers.
Efforts should be made to break up the mammoth elephant into small corporations and the means of privatising certain parts should be explored. Higher fares, we hope, will increase safety of passengers.
A lot of factors point out that this may not be the only bitter pill. There could be many more.
Wholesale Price Inflation (WPI) touched a five-month high at 6.01% in May 2014. This means RBI will need to revisit its June 2014 decision of holding the benchmark interest rate at 8% in its next policy review.
Read: Explained: The real story behind railway passenger fare hike
Any increase in interest rates will lead to an increase in EMIs for retail consumers and increase funding costs for corporates. Sugar prices have increased by Rs. 2 per kg due to hike in import duty to 40%. Prices of onions/potatoes are again witnessing an increase. Inflation may rise further.
Oil prices have increased by 5% since the start of June due to a war-like situation in Iraq. Increase in crude prices is bad news for an economy which imports 80% of its oil requirements.
Since in India prices of diesel, kerosene and LPG are controlled, this will increase the under recoveries of oil marketing companies which in turn will increase the subsidy bill of the government. The government has a fiscal deficit target of 4.1% for fiscal 2014-15. Rupee is above 60 against the dollar again (it had strengthened to 58.2 — its best performance in the last one year — on the day Modi took oath as the PM).
This is again not a good news for a country which is a net importer. This would inflate our current account deficit. It will have a far-reaching impact on companies which import raw materials to manufacture products. Things are going to get costly and pinch the common man.
Read: An open letter to finance minister from salaried class
Monsoon has been bad — at 45% below average — in June. This spells trouble for an agrarian economy like India's. Lower food production and a drought-like situation will lead to spike in food prices. There could be call for massive loan waivers for farmers which will further put pressure on the deficit.
With decline in agriculture growth (due to bad monsoons) and pressure on manufacturing sector (due to high interest rate environment), the GDP growth may stay at 5% levels.
As a result, the government may be left with no choices:
a) Petroleum product prices may be de-regulated to rein in subsidies
b) Income taxes could be hiked for the so-called rich; a new tax bracket of 40% may be introduced for income of Rs. 50 lakh
It would take some time before the economy recovers.
But, Modi would also not like to take profligate steps which would give ammunition to the rating agencies.
The rating downgrade threat is past us with NDA securing a thumping majority. However, any fiscal indiscipline will annoy the rating analysts.
Modi has to tread cautiously, people in India have a short memory and want quick fixes. The billion-plus population hopes he will deliver. Global factors may spoil his party though.
Modi needs to learn from mistakes of the BJP's 2004 debacle.
Views expressed by the author are personal.