A New Budget for India
Week of July 25, 2014
Expectations over India’s new Narendra Modi government have been high, given the decisive mandate that the Bharatiya Janata Party (BJP)-led coalition managed to win in May’s national elections. This was the first majority won by a single party in 30 years. In this context, the annual federal budget was more widely anticipated than usual. The market perceived this budget, presented in July, as a window into the thinking of the Modi government. Investors expecting substantial reforms were disappointed.
Nevertheless, we believe that the budget was an unrealistic barometer for the government’s effectiveness in enacting reforms. As a result of the election cycle, the BJP-led government had less than two months to prepare a budget to cover a truncated fiscal period, which ends next March.
Hence, as we look at the budget, we focus more on the government’s underlying intent and less on big bang reforms. In this regard, the government appears to have taken preliminary steps: The foreign direct investment (FDI) restrictions in the insurance and defense sectors were raised from the earlier 26% to 49%, though still short of the 51% desired by investors that enables foreign ownership control. The government is sticking to a deficit target of 4.1% for the current year as well as deficit targets of 3.6% next year, and 3.0% in financial year 2017. This is a commendable step toward fiscal consolidation. But these reductions rely on healthy tax increases, which may not pass if the economy remains sluggish.
The budget lacked any radical departures on subsidies. We suspect the government will shy away from headline grabbing efforts to curtail subsidies, given upcoming state elections slated for later in the year. The focus appears to be in ensuring that there is minimal leakage in delivering subsidies given the widespread corruption in these delivery mechanisms. The previous government had conceived and partially implemented the Aadhar scheme, a biometric based ID that authenticates every resident. It is noteworthy that the Modi government is moving forward with renewed vigor the previous regime’s flagship Aadhar program.
There appears to be a drive to reduce government holdings in the state-owned companies. In addition, the government announced measures to spur investments in infrastructure such as roads and power.
Specifically, we are interested in improvements in infrastructure—such as roads, railways and power plants—because of the high multiplier effect associated with infrastructure spending. The budget proposed a US$697 million (42 billion rupee) allocation for reviving a waterway connecting the eastern and northern parts of India, running 1,000 miles inland. This can provide a fillip to coal transportation which has been hampered by the paucity of rail infrastructure. Given the importance and easy availability of coal in the country, an inability to transport it effectively has forced industries to operate at below capacity.
In all, the budget followed a realistic script. We look forward to the months ahead for stronger signs of real reform efforts. A country of India’s size and poverty needs these reforms, specifically in labor and infrastructure to ensure that a substantial low-cost manufacturing base is established, paving the way for measured and sustainable long-term growth.
Sudarshan Murthy, CFA
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