Instead of a big bang, the reaction to India’s first budget under Prime Minister Narendra Modi was more of a whimper.
The highlight of the budget was a vow to lift economic growth to 7–8 percent within the next three years. Also, in a bid to attract new capital, the foreign ownership caps on defense and insurance industries are to be raised to 49 percent from the previous cap of 26 percent.
On the positive side, the new government stated its goal to bring down the fiscal deficit from 4.1 percent this year to 3.6 percent next year and then 3 percent the following year by overhauling the extensive subsidy programs for the poor and by introducing a goods and services tax this year. Investors actually cheered Finance Minister Arun Jaitley’s announcement of the tax, because it would replace a confusing array of state and federal taxes. Interestingly, federal spending on defense is to be boosted by 12 percent to $38 billion to help modernize India’s military and narrow the gap with China.
To help sway foreign investors, India would set up a mechanism to review retrospective tax claims, such as the $2.2 billion claim against the telecom giant Vodafone. The government also announced plans to sell an unspecified amount of shares in the debt-strapped state-owned banks, which will require large capital infusions.
Physical infrastructure, which remains India’s Achilles heel, will be getting a boost as the government plans to spend $1.1 billion to build 100 “smart cities” and promote investment in factories, roads, and ports. With an urbanization rate of only 30 percent, a faster migration from the farms to the cities will go a long way in improving productivity and economic growth.
But for many investors, the budget fell well short of expectations. Besides the complete lack of details on many issues (such as how the budget deficit would be significantly reduced), the biggest disappointment was the government’s failure not to open foreign direct investment to a wider swath of industries. Nothing was mentioned about a further opening of the critical retail sector. Currently, 40 percent of Indian food spoils before reaching the market. No mention either about India’s labor law requiring employers of more than 100 to obtain permission from the government before laying off workers. The current law is a job killer.
The growth target of 7–8 percent also seemed lackluster. (There was no mention of longer-term growth prospects.) India was growing at these rates just a few years ago. Given India’s demographic profile and low per-capita income, it is fully capable of generating average annual growth rates of 10 percent during its “catch-up” phase. Absent any “big bang” reforms largely missing in this first budget, India’s growth in the next few years will largely depend on decent monsoon rains to help the rural sector and external factors such as energy prices and global economic activity.
Investors were also disappointed that there was no announcement about a reduction in the securities transaction tax. The stock market reflected investors’ ambiguity and disappointment. While the benchmark Sensex stock market fluctuated a good deal during the day, it ended the day down 0.3 percent.
Rating agency Moody’s stated that the lack of detail made it “challenging to assess the credit impact” of the budget but noted it would keep India’s investment grade rating.
A strong India is in America’s interest for economic reasons but also for regional political and security reasons. This budget was not the opening signal either the markets or the best friends of India in Washington were expecting.