India's 2014 Budget
Enduring Challenges and New Responses
On July 10, India’s new government presented its much anticipated first budget. The budget offers a blueprint for what the new government will do to address the economic challenges that have contributed to India’s subpar 5% growth rate. Prime Minister Narendra Modi came to power promising to address these challenges and deliver a pro-growth, reform-oriented fiscal agenda that would get India’s economy back on track. Does the Modi government’s budget deliver on this agenda? In an interview with NBR, Pravakar Sahoo from India’s Institute of Economic Growth, currently Erasmus Mundus Scholar at the University of Antwerp, elaborated on the policies presented in the budget and the reforms the Modi government is seeking to implement in the current fiscal year. Dr. Sahoo argues that while the budget contains no “big bang reforms,” it introduces several measures to stabilize the Indian economy and bring back the level of investment necessary for India’s economic recovery.
The Modi government recently presented its budget, which will serve as the road map for the next fiscal year. Which areas represent a significant departure from the policies of the last government? What were the main highlights from this budget? Were there any surprises?
It’s necessary to understand the context in which the budget was presented. High inflation, dwindling growth, low investor confidence, job loss, and policy paralysis in many areas in the last few years had resulted in high expectations from Indian industry, investors, and ordinary citizens. Everybody was looking to the new government, led by Prime Minister Modi, to ease their pain. However, when the finance minister, Arun Jaitley, presented the budget for the remaining eight months of the current financial year, he faced several challenges to meet all of these expectations. These challenges included a depleted exchequer, uncertain oil prices due to the crisis in Iraq, and rising food prices due to a bad monsoon. Given this context, the first budget of the Modi government may not fulfill expectations across all sectors of society. Nonetheless, it is an excellent start and clearly states the intention of the government to revive the economy and bring it back on a high-growth trajectory of 8%-9% growth rate in the next two to three years.
The $301 billion budget is largely investor and investment friendly, but it does not make a radical departure from previous years. Nonetheless, the budget includes some positive measures that will help the Indian economy in the short to medium term. The main highlights are the budget’s focus on infrastructure (roads and highways through the National Highway Authority of India, building and improving ports, smart cities, airports), the hike in FDI caps in the insurance and defense sectors to 49%, the intent to do away with retrospective taxes (although pending cases will not be squashed and will be screened by high-level committees), and the allocation of the large sum of $37.5 billion for the defense sector. Infrastructure investment trusts—an investment instrument—have been provided with tax incentives, thus dealing with the issue of funding infrastructure. Raising FDI limits on e-commerce, insurance, defense, and health insurance provides another sign that the government is headed toward serious reform. Plans to decontrol diesel prices within a year were also announced, further signaling a shift toward market-oriented policies. Overall, the planned expenditure in the present budget is 29% higher than in 2013-14. In addition, the budget’s emphasis on the social sector, from elementary education to rural development, was welcomed throughout society.
The main focus of the budget is on infrastructure and manufacturing. In fact, this could be called an infrastructure budget. The budget has given due emphasis to all physical infrastructure, including roads, rails, ports, and aviation infrastructure, which had been the major obstacle for increased investment, manufacturing, and growth in the Indian economy. The new government has allotted almost $6.33 billion for national highway development and another $2.4 billion for development of roads under the prime minister’s road program (known as Pradhanmantri Sadak). The objective of this funding is to interconnect cities and achieve a quality national highway network with 8,500 kilometers (km) in roads—national highways being a key medium of transportation in India.
Other infrastructure measures in the budget include $1.18 billion for the development of 100 smart cities and new airports through public-private partnerships (PPP), $1.83 billion for the construction of sixteen new ports, and $700 million for the waterway development project (Jal Marg Vikas) on the river Ganga, connecting Allahabad to Haldia. Moreover, the announcement of plans to develop 15,000 km of gas pipeline through a PPP, the allocation of $83 million for solar projects, plans to develop metro rails in other cities through the PPP model used for Delhi Metro, and the allocation of $833 million to the National Bank for Agriculture and Rural Development for rural infrastructure are several other highlights.
Finally, the budget allows banks to issue long-term bonds without subjecting them to cash reserve and statutory liquidity ratios for financing infrastructure, an innovative approach that encourages the banking sector to finance infrastructure projects. Other steps such as increases in the tax exemption limit, hiking the taxable income limit, and placing tax exemptions on housing loans to incentivize financial savings are encouraging developments as well.
A growing budget deficit, the scale of which was perhaps underreported by the previous government, will limit India’s economic recovery. Are there specific and credible steps to contain the fiscal deficit?
The government has set a stiff target for itself in terms of fiscal consolidation and has maintained the previous government’s interim budget fiscal target (presented in February 2014) of limiting the fiscal deficit to 4.1% of GDP in the current fiscal year. The Finance Ministry’s target of achieving a 3% fiscal deficit by 2017 lays the framework for fiscal consolidation. However, achieving the 4.1% target this financial year depends on increased tax revenues that would result from a substantial—if doubtful—recovery of the economy, new revenues from service sectors, and huge disinvestment proceeds. The Modi government announced that tax collection will be 19% higher than the previous fiscal year, and the disinvestment target has been set at $8.33 billion. These will be difficult goals to achieve in the current fiscal year. In his follow up briefings the finance minister was positive and determined to achieve the target of a fiscal deficit of no more than 3% of GDP by 2017. Thus, at the very least, the government has succeeded in sending a clear message that it is serious about fiscal consolidation.
There was considerable interest in how Modi would address tax policy, which has been hotly debated due to questions about fairness and the need for revenue generation. What does the newly released budget reveal about Modi’s policies?
No significant proposals were made with respect to tax reform. The Modi government gave assurances that the direct taxes code will be reviewed soon and that pending issues around a goods and service tax (GST) would be resolved within a year. But no timeline for implementation of a GST was mentioned, not least because the tax must be implemented in consultation with Indian states and the states will need to be compensated for lost revenue. The earlier United Progressive Alliance (UPA) government could not implement a GST because states ruled by the National Democratic Alliance (NDA) opposed the measure. As the central government is ruled by the NDA itself, a move toward a GST should be easier than in the past, and the finance minister has essentially made that promise. Overall, the finance minister has tried to give the impression that the tax system will be more transparent as well as friendlier to both people and businesses.
As for tax policy, no new retrospective taxes will be levied; however, contrary to what corporate interests—particularly foreign investors—desired, existing retrospective tax cases will be reviewed but not automatically rescinded. In short, the Vodafone case will continue: the government of India proposed to amend a 1962 tax law in the 2012–13 budget with a retrospective effect that could result in Vodafone paying around $2 billion in taxes on the purchase of a controlling stake in the Indian mobile-phone unit of Hong Kong–based Hutchison Telecommunications International Ltd. However, on the positive side, long-term infrastructure bonds will receive tax exemptions.
There has been much discussion on the importance of a resurgent manufacturing sector for achieving Modi’s goals of boosting employment and increasing overall economic growth? How can Indian competitiveness be increased so that India becomes a global manufacturing leader?
The budget has attempted to address issues in manufacturing through a few key steps, such as moving to revive special economic zones (SEZ), giving an investment allowance of 15% for up to three years to manufacturing companies that invest more than $4 million in plant machinery, announcing special SEZs for women in one hundred districts, and raising FDI in the insurance and defense sectors to 49%. Most importantly, the finance minister’s pledge to fast-track project clearances and reduce delays for businesses is a welcome step.
The budget reiterated the government’s agenda to improve the skills and employability of young Indians by announcing plans to open five new Indian Institutes of Technology and five new Indian Institutes of Management across the country. The government also will focus on creating industrial tier-II and tier-III cities and on skill development for job creation and manufacturing. Other encouraging steps include a $1.67 billion start-up fund for new businesses, a $17 million disbursement for a start-up village entrepreneurship program targeting the rural population, $33 million for scheduled caste entrepreneurs, and a $17 million investment in the Young Leaders Programme. Well-developed infrastructure is a must for manufacturing to take off and to attract increased FDI. In this regard, and as mentioned above, the budget appears to have made great progress. Moreover, FDI policy has been liberalized for the construction sector with the objective of setting up smart cities, and this measure too should improve the manufacturing sector. Finally, if power companies start generating power for distribution by March 2017, they are entitled to a ten-year tax holiday.
Inflation, particularly food inflation, is very high in India and expected to increase due to a water shortage this season. What steps has the Modi government taken to reduce inflation, and how will they affect India’s monetary policy and overall growth?
Inflation remains a major worry, given that rainfall this year has been below average, ranging from 20% to 40% of normal levels in various regions. If the rainfall does not recover in the coming weeks, it would certainly affect food prices in the near future. The Modi government is well aware of the political cost of inflation and has taken necessary steps like instituting strict rules against hoarding, banning exports of some food grains, and bringing a few food grains under the Essential Commodities Act. Fortunately, last year witnessed a good harvest of around 260 million tons of food grains, giving the government a buffer to avoid an unexpected surge in food prices.
Moreover, the present government’s emphasis on fiscal consolidation may make monetary policy more effective and reduce core inflation over time. The government has also linked different social schemes to asset creation, which in the medium term might improve goods and services.
In brief, what is your overall assessment of the Modi government’s first budget?
Fiscal consolidation, infrastructure, manufacturing, and the GDP growth rate continue to be the focus areas of the government in its maiden budget. There were no big bang reforms in this budget. However, it takes several good steps intended to stabilize the economy and bring back the high investment that is needed for India’s economic recovery.
Pravakar Sahoo, currently Erasmus Mundus scholar at the University of Antwerp, is an Associate Professor at the Institute of Economic Growth (IEG), Delhi University, and a former South Asia Fellow at the East-West Center in Washington, D.C.
This interview was conducted by Ved Singh, an Intern at NBR.