Indeed, the better than expected performance of Indian economy last year had a lot to do with a significant fiscal stimulus and loose monetary policy. In fact, two stimulus packages providing tax cuts and increasing infrastructure spending in connection with lower interest rates have supported significantly domestic demand. Yet, sooner or later the effect of fiscal incentives will fade leading to a slowdown in factory production. In addition, inflation is becoming a growing concern. Weaker monsoon has pushed cost of food significantly higher in the last few months. This price pressure combined with strong industrial production may soon lead to interest rate hikes and tighten credit availability.
Looking further, stimulus spending had expanded fiscal deficit from 2.6% of GDP in 2007/08 to projected 6.7% in 2009/10. And although due to strong growth numbers the shortfall is more than sustainable, Indian government should be able to better control its expenditure. In fact, while Union Budget for 2011 increases infrastructure spending, raises taxes for petroleum products and reduces for middle-income families it fails to slash inefficient subsidies on fertilizer, fuel and food. More importantly, the new administration is slow in implementing economic reforms promised investors after last year's wider-than-expected election victory. The government has made progress in new tax laws, disinvesting state run companies, it formed an experts panel to ease foreign investment in the financial sector. Yet, labor reforms and farm prices release are far from being executed.