Reality Check: What Is India’s New Budget
Telling Investors?
By Larry Cao, CFA
Categories: Economics, Portfolio Management, Private Wealth Management
Earlier this month, newly elected Indian Prime MinisterNarendra Modi’s
administration delivered its first budget. This bears serious attention as the
budget is a good indication of the government’s focus and prioritization over the
remainder of fiscal 2014 and the entire fiscal 2015.
Modi’s Decisive Win Has Generated a Lot of Enthusiasm
Investors have high hopes for the new government. This is obvious by looking at
the Indian stock market, which started to pick up pace months before the
election. The excitement is also evident in the investment community. Angus
Tulloch, head of Asia Pacific Equities at First State Stewart, wrote in a recent
client note after visiting India: “I have never ever seen a business community
anywhere so enthusiastic about the election of a new political leader.”
“Modi was described again and again as a decisive, driven and far-sighted leader
who is determined to improve India’s economic growth rate,” Tulloch went on to
say in his report.
India Inc.’s thirst for growth is understandable. Thirty-five years ago China was its
poor neighbor. Today it is India that has been left by the wayside in terms of
economic growth and level of GDP per capita.
When I spoke with Navneet Munot, chief investment officer at SBI Funds, after
the Indian election, he also expected the new government to push businessfriendly policies and attract foreign investments. By building physical and social
infrastructure and at the same time implementing fiscal consolidation, he expects
India’s manufacturing sector to become more competitive.
That Enthusiasm Can Only Be Partially Met by the Budget
Here are my take-aways from this budget.
First, it’s a tough balancing act. Anyone who has had to balance her own family
checkbook knows it’s not possible to spend more when getting paid less, at least
not for long. Unfortunately that is the challenge the Modi administration is facing.
The new government clearly appreciates the value of fiscal discipline but also
has to commit to a sufficient number of projects to create momentum. The
budget strikes a delicate compromise that starts from the good intention of
keeping the fiscal deficit in check. Many economists, however, have questioned
how tax revenue can grow close to 20% while nominal GDP is only expected to
grow by 13% (real GDP growth of about 5–6% plus inflation). So progress
towards that goal bears watching. For example, will the government resort to
borrowing to keep the projects going if revenue growth falls short or will the Modi
administration speed up the privatization effort?
Second, infrastructure projects have received prominent attention in this budget.
The planned capital expenditure increase is keeping pace with the aggressive
projected revenue growth at 18.8%. The increase is significantly higher than in
previous years. The money is flowing into infrastructure projects such as power,
ports, shipping, and irrigation. This is probably the most promising aspect of
budget.
Third, the new government has clearly chosen an inclusive path by watching out
for the interest of lower-income families. This is reflected throughout the budget
in a multitude of initiatives that aim to control inflation, and such agricultural
initiatives as measures to improve irrigation, expanding the food processing
industry, and establishing a food stabilization fund. These will all have positive
effects in terms of stabilizing food prices over time.
Food subsidies will continue to grow while overall subsidies will stay almost flat.
The pragmatism demonstrated by this new administration, however, will likely
disappoint those who see subsidies as a waste of resources or a distortion of the
market mechanism and wish to do away with them ASAP.
India Has a Long Road Ahead
Marc Faber, author of the Gloom Boom & Doom Report, recently said in an
interview, “I believe that the budget will rather disappoint than support the reform
that so many people are expecting. It is very difficult to address the issues in
India of a multitude of subsidies and of the fiscal deficit and at the same time roll
out infrastructure.”
Even if we remain optimistic on India’s future growth potential, the “inconvenient
truth” about economic reforms is that it takes time for the policy measures to be
put in place and take effect. The task at hand is often more complicated than it
seems, and resources are limited. For example, key measures at improving
India’s competitiveness, such as education, infrastructure investments, and
attracting foreign investments, are all long-term goals in nature. Throwing money
at these issues is also not a realistic solution given the long-term nature of the
spending needs.
As much as everyone hopes for a silver bullet, there is probably no better way
ahead than setting the right direction and strategy and keeping to it. That seems
to be exactly what the Modi administration is doing.