India’s 2013-14 Budget: A Reflection of Political Priorities and Economic Environment?

India's 2013-14 Budget
A Reflection of Political Priorities and Economic Environment?

Interview with Raymond E. Vickery Jr.
March 29, 2013

In February, India released its last budget before nationwide general elections, scheduled for the first half of 2014. This 2013–14 budget, the first announced by Finance Minister P. Chidambaram, includes a 16% projected increase in government spending and new taxes on the wealthy and large companies. The budget comes amid slowing economic growth and lagging investor confidence, and was released hours before figures were announced showing that the economy grew at only 4.5% during the last three months of 2012, the slowest rate in nearly four years. India has also reported a record current account deficit.

In an interview with NBR, Raymond Vickery Jr. (Albright Stonebridge Group) discusses the budget’s key announcements and provides insights on its potential to spur economic growth and attract foreign direct investment. He argues that the 2013–14 budget differs in important ways from the one announced in March 2012. Among other differences, it reflects changes in the economic environment, as seen in the September “big bang” reforms, and is an opportunity for the ruling United Progressive Alliance (UPA) government, led by the Congress Party, to address its political priorities and core constituencies.

What are the key announcements in India’s new budget?

This is the last Indian budget prior to the nationwide parliamentary elections that must take place no later than the spring of next year. Thus, the 2013–14 budget reflects the political priorities of the ruling United Progressive Alliance (UPA) government as led by the Congress Party. The key announcements are designed to appeal to the core constituencies of the UPA, particularly Scheduled Castes, Scheduled Tribes, Other Backward Classes, minorities, and women.

The Scheduled Castes, Scheduled Tribes, and Other Backward Classes are categories of citizens who have historically been economically disadvantaged by the caste system and the social stratification of Indian society and are identified in India’s constitution as being eligible for special treatment to remedy their disadvantages. For these groups, Finance Minister P. Chidambaram announced an increase of 12.5% over the budgeted expenditures for the previous 2012–13 fiscal year and 31% over real expenditures during that year. These taxes were put into place to raise revenue and show that the priorities of the UPA are not with the wealthy. The UPA also announced increased spending on the Backward Regions Grant Fund and similar programs.

Since these groups make up a majority of the population and the vast bulk of the poor, it is worthwhile to note that Minister Chidambaram reiterated the UPA government’s commitment to the goal of a direct benefit transfer (DBT) program to replace the chaotic mechanism through which subsidies and benefits are presently provided to the poor. This would be a sea change in India and strike directly at aspects of the bureaucratic corruption that is endemic. Minister Chidambaram assured the people of India that “the DBT scheme will be rolled out throughout the country during the term of the UPA Government.”

Minorities, who are largely Muslim, are particularly important politically to the UPA in preparing for the elections of 2014 because the likely opposition candidate for prime minister, Gujarat chief minister Narendra Modi, is from the Hindutva nationalist Bharatiya Janata Party. The announced increase in the budget allocation for the Ministry of Minority Affairs is 12% on a budget basis and 60% on a real expenditure basis. Likewise, the foundation that is the main vehicle for funding educational programs and NGOs that help minorities received a 17% increase in its corpus fund and had medical aid added to its objectives with the promise of doubling the fund by 2017.

The status and safety of women is a particularly salient issue in India after the Delhi rape case and the nationwide demonstrations and soul searching it engendered. Minister Chidambaram announced substantial gender and child budgets with appropriations for designing programs to address concerns about self-esteem, dignity, and gender discrimination. The budget also includes funding for the Ministry of Women and Child Development to work on the problem of violence against women. On issues generally thought to appeal more forcefully to women—health and education—increases of 24% and 17%, respectively, were announced. Minister Chidambaram also noted that women headed major banks in India and announced the establishment of a women’s bank.

On direct taxes, the key announcement, with considerable political overtones echoing the debate here in the United States, was a surcharge of 10% on those making more than approximately $200,000, companies with taxable income over $2 million, and dividend income. Also included were a variety of tax increases on luxury items.

For foreign investors, uncertainties created by anti–tax avoidance rules were ameliorated and postponed. However, the extra-territorial tax initiatives surrounding the infamous Vodafone case were left unresolved. Thus, the new budget has caused considerable unease about the procedural and substantive due process of Indian tax laws and administration.

Also of key concern to foreign investors and exporters to India of technology and services was the unexpected announcement of a tax increase from 10% to 25% on the distribution of profits by a subsidiary to a foreign parent company in the form of a royalty. This tax also applies to all royalties and fees to nonresidents for technical services. India wants technology, but this increase in taxes on royalties and fees is bound to discourage technology transfers and is antithetical to India’s own interests.

In regard to defense, the key announcement was that spending increased by only around 5% on a budgeted basis and 14% on a real expenditure basis. This is about a third lower than defense spending has been running for the past few years and calls into question the ability of India to play an expanded military role in the Indian Ocean and Asia as a whole.

What are the goals of this budget?

As indicated, the 2013 budget is primarily an inward-looking document for domestic consumption. The finance minister’s mantra is “higher growth leading to inclusive and sustainable development.” I discussed the “inclusive” aspects of the budget for women, minorities, and the socioeconomically disadvantaged in my answer to the first question. However, one other goal pertaining to “inclusive development” is noteworthy.

Although 54% of Indians are under the age of 25, historically there has been very little attention paid from a budgetary standpoint to youth as such. Perhaps because of Rahul Gandhi’s campaign to become the fourth generation of the Nehru-Gandhi family to lead India and his trademark political outreach to youth, the new budget includes a special section on training goals for youth. Minister Chidambaram proposed to appropriate the equivalent of approximately $200 million for national training for 10 million youth. Curriculum and training standards would be developed, and any institution could offer the courses. A test would then be administered by authorized certification authorities, and students who pass would receive not only a certificate but also a monetary award.

On the “sustainable development” goal of the budget, Minister Chidambaram has basically interpreted “sustainable” in macroeconomic terms. This budget contains no new populist but budget-busting schemes. The forgiveness of farmers’ debt, rural employment schemes, and increased subsidies of former budgets are downplayed in favor of prudence. As to the environmental side of “sustainable development,” the budget gives little notice. There is mention of waste-to-energy projects, lending from the National Clean Energy Fund, and a “generation-based incentive” for wind energy projects, but little more.

How will the 2013 budget affect India’s fiscal deficit and short-term prospects for reaching 6.0%–6.5% GDP growth this year? How might the budget announcements affect the country’s long-term growth prospects?

In the budget, the UPA government accepts the recommendation of a committee of experts for “red lines” of a fiscal deficit of 5.3% of GDP for this year and 4.8% of GDP for 2013–14. Minister Chidambaram says that the deficit for 2012–13 is estimated at 5.2% of GDP and that this budget will hold the deficit to 4.8% in 2013–14.

However, this goal cannot be met unless there is substantial growth in the economy. On this score, Minister Chidambaram “unhesitatingly embraces growth as the highest goal.” However, the budget does remarkably little to support this goal in the short run. On taxes, the Minister Chidambaram acknowledges that there is little room to either substantially raise or lower taxes. However, he sets a short term goal of raising the tax-GDP ratio from 9.9% to 11.9%—a goal hardly calculated to stimulate growth. Rather than reaching for a short-term goal of 6.0–6.5%, Minister Chidambaram accepts estimates by the Central Statistics Office and Reserve Bank of India of current fiscal year growth at 5.0–5.5% (it was 4.5% for the last quarter of 2012) while acknowledging getting back to a growth rate of 8% only as “a challenge that faces the country.”

This unwillingness to embrace stimulus measures in a manner equal to the embrace of growth as the “highest goal” is perhaps understandable given India’s inflation rate, which is running at about 7.0% per annum. However, inflation is at a three-year low, and one might have expected a bit more emphasis on growth mechanisms and a little less on long-run economic sustainability.

Thus, the budget is unlikely to give much of a short-term boost to growth but is more likely to boost India’s long-term economic prospects if future budgets continue to exhibit fiscal restraint. The UPA government appears intent on letting the Reserve Bank of India handle short-term stimulus of the economy, as the bank has done recently by reducing a key rate for lending.

How might announcements in the budget affect FDI?

Minister Chidambaram has frankly acknowledged that he is more worried about the current account deficit than he is about GDP growth. This could be good news for FDI, since he also acknowledges that only foreign investment or external commercial borrowing can fill the gap between current account inflows and outflows. Implicit in this approach is the undesirability of external commercial borrowing, which leads Minister Chidambaram to the conclusion that “foreign investment is an imperative.”

In words designed to gladden the hearts of investors, Minister Chidambaram said in his budget speech that “the key to restart the growth engine is to attract more investment, both from domestic investors and foreign investors….’Doing business in India’ must be seen as easy, friendly and mutually beneficial.” This sentiment is directly on point, since the World Bank ranks India 132 out of 185 economies in its “ease of doing business index.” By way of comparison, the United States ranks 4 and China 91.

One way in which the ease of doing business in India can be improved is to clean up confusing and conflicting standards about FDI. This is important since India has four different avenues for investment with considerable overlap and differing regulations for the process of investment. Under the new standard, if an investor has a stake of 10% or less in a company, this investment will not be treated as FDI and will therefore not be subject to pricing guidelines, sectoral restrictions, minimum capitalization, and lock-in requirements.

However, the new budget does nothing to ease these restrictions on FDI. In particular, nothing was announced to build on the changes in FDI caps for multi-brand retailing, airlines, power exchanges, and broadcasting announced by the government in September 2012. Almost all caps on the FDI of foreigners should be raised or removed. These caps reflect a historical fear of economic imperialism that is outmoded given the ability of India to govern itself. The complex regulation of FDI that must come via the governmental route is unduly time-consuming and expensive, and the process should be streamlined. Lock-in requirements for FDI should be lessened. Requiring investors to wait years before they can get out of investments discourages FDI. The requirements for foreign investment in multi-brand retailing, including 50% for back-end infrastructure and 30% of the value of goods to be purchased from small industries, are likewise counterproductive. The market should decide these matters. Finally, investment caps and restrictions, such as those surrounding the announced allowance of 51% FDI in multi-brand retailing, continue to be a major impediment to FDI.

In fact, some of the announcements in the budget seem to discourage FDI. For example, in regard to what constitutes conclusive evidence of residence for taking advantage of bilateral tax treaties, such as the treaty with Mauritius, a valid tax residency certificate issued by the foreign government will no longer be accepted as conclusive proof of residency. To make matters worse, there is nothing in the budget to define what constitutes sufficient proof of residency. Similarly, while favorable mention is made of the National Policy on Electronics in regard to domestic wafer manufacture, nothing is said or done about the protectionist aspects of that policy, which are in some respects similar to the solar panel restrictions that have recently become the object of a WTO trade dispute between the United States and India.

Infrastructure should be a prime area for increased FDI by U.S. companies. One of the difficulties in making such projects work has been the inadequacy of complementary funding. In that regard, there is some good news in India’s budget. Infrastructure debt funds will be encouraged and additional institutions will be allowed to issue tax-free bonds. Furthermore, stock exchanges will be allowed to create dedicated debt segments. The Cabinet Committee on Investment will take up additional projects with a view to removing bottlenecks and quickening the pace of implementation.

All in all, however, there is no major announcement in the 2013 budget that will likely engender significant additional FDI for India.

What are the main differences between this budget and the 2012 budget? What do these differences say about the Indian government’s current priorities?

To a large extent, the differences between last year’s budget and this one reflect the changed economic circumstances of India as well as the change in leadership at the Ministry of Finance. The 2012 budget reflected a mindset that India had weathered the worldwide economic crisis better than most other nations, particularly those in the West. Economic growth was projected at some 7.2%. Then finance minister Pranab Mukherjee, who is now president, delivered a budget largely based on optimistic predictions. It forecast that India would be able to handle significant increases in expenditures for the some 60% of Indians who make their living from the land without disturbing the vast system of price controls and subsidies that have become endemic to the nation. The approach to foreign investment was careless at best with the vagaries in Indian taxation, exemplified by the infamous Vodafone case, largely dismissed as the complaints of the wealthy generally and wealthy foreigners particularly.

The year 2013 is different in several important ways for India, and the budget reflects those differences. The optimistic projections of resumed GDP growth have not come true and turn out to have been considerably inflated, while foreign investment has not grown at anything like the rate necessary to fill India’s current account deficit. Minister Chidambaram has a realistic view of India’s situation. He knows that he must maintain fiscal stability in order to produce long-term growth and that his resources for producing markedly increased growth in the short run are limited.

Minister Chidambaram likewise fully appreciates how much India’s economy is linked to the world economy. He would like to make that relationship more positive than it is by implementing reforms that will increase domestic vibrancy and foreign investment. He is constrained, however, by domestic politics and traditional skepticism of both capitalism and foreign economic involvement. Consequently, although he has made statements approving of the use of markets and foreign investment, he has attended first to the political issues important to his coalition’s core constituencies ahead of the upcoming national elections. He has made some improvements, but no “big bang” changes.

The 2013 budget is thus designed to satisfy the immediate political demands of the UPA’s core constituencies in a way that will provide, in the words of Minister Chidambaram, the “economic space” (i.e., resources) to achieve the coalition’s socioeconomic goals. However, this budget itself provides very little of that “space.” The hope instead must be that it will contribute to providing that space in future years.

Raymond Vickery is a Senior Director of Albright Stonebridge Group, a global strategy firm, where he advises clients on India-related matters. He is widely known for his work promoting U.S.-India economic cooperation, including while serving as Assistant Secretary of Commerce for Trade Development in the Clinton administration, and has many years of experience advising multinational businesses on India.

This interview was conducted by Sonia Luthra, Assistant Director, Outreach, at NBR.