Indian Prime Minister Narendra Modi came to power in 2014 with a promise: "Less government, more governance." When it comes to the economy, it turns out India can't afford less government just yet.
It's not that Modi hasn't tried. He's made it easier to start a company, streamlined bureaucratic procedures and eased restrictions on foreign ownership. However companies aren't following through with investment as a fractious parliament blocks key bills, bad debt chokes credit lines, and China's slowdown jeopardizes global prospects.
That's left Modi to spend on roads and ports to spur growth, even at the risk of worsening Asia's widest budget deficit. Manufacturing slack at companies means it will take time before four interest-rate cuts in 2015 begin to boost investment rates.
"We are not too confident of a private sector investment recovery-led growth," Kunal Kundu, a Bengaluru-based economist at Societe Generale SA, said by e-mail. "There's still a long way to go for balance sheets to be properly cleaned up."
Even before Modi won India's largest electoral mandate in 30 years, investors including Goldman Sachs Group Inc. had said he's viewed as "business-friendly" and "an agent of change." However, the structure of India's legislative system and losses in state polls means he lacks a majority in the upper house of parliament, where the opposition has stalled crucial bills in tit-for-tat politics.
Modi also can't expect much help from the central bank, where economists say Governor Raghuram Rajan will keep borrowing costs unchanged until at least June as inflation threatens to stay above his 2017 target.
That means fiscal policy would need to do the heavy lifting through expenditure on roads and railways or the more likely route of boosting consumption through a scheduled pay hike for state employees and an increase in military pensions.
"The coming budget is crucial," said Jay Shankar, an economist with Religare Securities Ltd. in New Delhi. Modi should consider building rural roads to connect India's cities to the hinterland and spur demand, while also better managing food supplies to keep prices in check, he said.
"These are the limited options before the government, outside the legislative logjam," Shankar said.
In its previous budget, the government vowed to reinvigorate the economy through public investment. The momentum was reflected in growth in fixed assets such as new factories, which jumped 6.8 percent in July-September compared with 4.9 percent the previous quarter, according to Nomura Holdings Inc.
But that's taken a toll on public finances. India's budget deficit was 87 percent of the full-year target in the first eight months alone and the Finance Ministry in December warned it may have to reassess next year's goal if growth slows.
There's also little sign of the private sector following. Stressed assets at a 13-year high keep commercial credit growth near a 20-year low, and capacity utilization stays below 75 percent.
Private projects under implementation rose 1.3 percent in October-December from a year earlier, compared with 15.2 percent for public projects, according to Morgan Stanley, which cited numbers from data company Centre for Monitoring Indian Economy Pvt. The Nikkei and Markit Economics's purchasing managers' index in December signaled a manufacturing contraction for the first time since 2013.
"It remains to be seen whether growing public investment can crowd in private investment on a sustained basis," central bank Governor Raghuram Rajan wrote in a Dec. 2 statement.
Investment demand will pick up gradually, Goldman economist Tushar Poddar predicts, helped by higher public spending and foreign direct investment, and Modi's "nuts and bolts" reforms that have pushed India to 130 in the World Bank's latest ease of doing business ranking from a revised 134. FDI rose 18 percent to $27 billion in the first nine months of 2015 from the previous year.
Modi's steps to help clear debt piled up at power utilities will also pay off in the long run, said Suvodeep Rakshit, an economist at Kotak Securities Ltd. In addition, Modi's administration has announced a plan to improve governance at state-run banks while helping them boost capital.
"Public-led investment growth is the way to go until you see at least the corporate balance sheets starting to improve," Rakshit said. "There is not two ways about it."
© 2016 Bloomberg L.P.