How will India fund "reforms with a human face"?

The newly-elected United Progressive Alliance (UPA), led by the Congress Party, released its Common Minimum Program (CMP) on Thursday 27 May, highlighting the main priorities, policies, and programmes of the new government. It promises 'reforms with a human face' but contains more rhetoric than substance.

The CMP contained few significant changes from the draft, which had been released several days before, and only vague indications of how the government's laudable spending and investment plans are to be funded. With a consolidated budget deficit approaching 10% of GDP, India has little fiscal flexibility. Tax reform appears to be the preferred route. There is certainly scope given India's low tax/GDP ratio (under 10%). However, given the need for agreement at the State level, reform has proved politically difficult in the past and will not be straightforward.

Privatisation has not been ruled out completely and will be dealt with on a case-by-case basis, but the already slow progress is likely to decelerate. That said, the tenders for stakes in the airports appear to be progressing with limited opposition, indicating that decisions are likely to be more pragmatic in practice than the rhetoric in the CMP suggests.

One notable change in the final version of the CMP was the intention to review the 2003 Electricity Bill, which maps out the privatisation of the sector and is widely regarded as an important step towards revitalising India's power infrastructure. The negative response from investors to the proposed review pushed the Sensex index down 4.4% on Friday, despite attempts by the finance minister, P. Chidambaram, to assure the markets of continued economic reform and high growth. He forecast growth of 7-8% this year, which is optimistic given the high base in 2003/04. The Reserve Bank of India's forecast of 6.5%-7% is more in line with market expectations, and we expect growth to be at the upper end of this range, driven by a revival in investment.

Foreign investors have remained nervous since the election result. Rebounds in the Sensex index on the ministerial appointments have not been driven by foreign funds, which have shown net negative outflows on all but two days since the result was announced. Investors are looking for more precise evidence of the government's polices.

The budget, due to be released in June or early July, will provide much more concrete evidence of the intended pace and funding of reforms going forward, and an indication of how the reform agenda will accommodate left-wing objectives in practice. Both the Prime Minister, Manmohan Singh, and the Finance Minister have strong reformist credentials - the first as the "architect of reforms" following India's 1991 balance of payments crisis, and the latter for the so-called "dream budget" of 1997. Their room for manoeuvre in the new coalition remains uncertain, but the prospects are positive given the strong political consensus on continued reforms (albeit refocused) and a combined desire to keep the coalition in power.