India — Modi’s Budget Is Growth-Oriented and As Expected
The release last week of the first budget from India’s new administration was about what investors expected. The Indian stock market had already run up substantially this year in anticipation of a likely victory by business-friendly Narendra Modi and his Bharatiya Janata Party (BJP). When Modi’s finance minister presented the budget last week, markets took a breather.
India’s Sensex Has Had a Strong Run In 2014
For us, in spite of challenges, the fundamental thesis remains in place. The budget didn’t have any surprises, and although it wasn’t everything analysts had hoped for, we note again that turning India’s giant ship is not a task that Mr Modi will be able to achieve overnight.
Modi’s Budget: The Good
We liked the budget’s provisions to encourage capital expenditures on plants and machinery. Modi’s tax incentives show that his administration is serious about encouraging broad-based manufacturing growth in small and medium-sized enterprises, not just among industrial giants. The budget also establishes a tax regime for infrastructure and real-estate trusts, with the intention that investment and household savings will thus be incentivized to flow into these sectors. That shows again that the government is serious about infrastructure development, but also serious about boosting that development in a fiscally responsible way, leveraging private sector investment through intelligent tax treatment.
India’s tax regime also saw general improvement, with policy efforts towards a system that is more transparent, less adversarial, and only prospective rather than retrospective. Retrospective taxes — in which a newly imposed tax can apply to past economic activity — have been cited by foreign investors as a key reason for their hesitation to invest in India. If Modi is serious about boosting foreign direct investment, in emulation of China’s development path over the past several decades, he will have to continue to improve India’s tax structure.
Besides efforts to build a tax regime that foreigners are comfortable with, the budget also liberalized permitted levels of foreign direct investment in the insurance and defense sectors (in defense manufacturing, for example, foreigners are now permitted to own 49 percent of a firm, up from 26 percent previously). This is an incremental shift that will be broadened as Modi is able to implement more reforms.
Modi’s Budget: The Could-Be-Better
Observers were disappointed that the budget didn’t provide a roadmap for the rationalization of fuel subsidies. There is already a public consensus in India about the country’s huge diesel subsidy, which remains a significant fiscal drag. As we have noted, however, this budget was released at a time of volatility in global oil markets, with geopolitical tensions continuing in the Middle East and Ukraine, and uncertainty about supplies coming on and offline in various countries. With this backdrop, we cautioned that Modi might hesitate to tackle fuel subsidies right off the bat. We continue to believe that Modi will tackle India’s subsidy regimen in the medium term — particularly if events play out to create a lull in oil price rises.
The budget also shied away from addressing food subsidies. Indian economic conditions depend heavily on the agricultural sector, and with a challenging monsoon season shaping up, the administration may have hesitated to affect food prices too drastically. (Precipitation is running 41 percent below average for the country as a whole, although the monsoon season may simply be late in starting.)
The markets were also underwhelmed by the budget’s infrastructure outlay — apparently expecting some more headline megaprojects such as those we have mentioned previously (for example, the Delhi-Mumbai industrial corridor). Still, there was a raft of infrastructure-related measures in the budget, from the investment trusts mentioned above, to improvements in power generation and distribution, roads, and various renewable-energy projects. Most of the infrastructure push is coming from tax treatment to encourage private-sector investment,
rather than big fiscal outlays. To us, this is a positive.
In short, the Modi administration’s first budget gives us a general picture that is very much in line with our expectations. It’s bold in some regards, incremental in other regards, focused on making India a friendly place for foreign investors, and focused on boosting infrastructure, but primarily by incentivizing private-sector investment. While we and others are impatient for the troublesome elements of India’s socialist past to be cleared away, we understand that this process won’t happen very quickly, and we are encouraged by the steps Modi has taken thus far and by the enthusiasm for reform that his campaign and election have helped to generate. We continue to believe that the medium- and long-term thesis of Indian reform presents an excellent strategic prospect for investors, and we will regard corrections in the Indian market as buying opportunities.
