India's 2015-16 Budget
Targeted Reforms to Promote Investment

Interview with Pravakar Sahoo
April 14, 2015

On February 28, 2015, India’s finance minister, Arun Jaitley, presented the much-anticipated 2015–16 Union Budget to Parliament. Most analysts view the budget—the second proposed by the Bharatiya Janata Party (BJP), led by Prime Minister Narendra Modi—as a critical indicator of the government’s priorities and willingness to execute the type of “big bang” reforms called for by advocates of greater market liberalization. Modi has staked his political future on India’s economic prosperity, promising to simplify regulations and improve the business environment. To promote these initiatives, he has set ambitious goals for his government, such as increasing GDP growth to 8% by the next fiscal year and decreasing the fiscal deficit to 3% by 2017–18.

In this Q&A, Pravakar Sahoo of Delhi University explores what the 2015-16 budget means for India, foreign investors, and India-U.S. defense cooperation. He argues that the budget, while focused on growing investment in the Indian economy, may not be the “quantum leap” that Finance Minister Jaitley has claimed it to be. Dr. Sahoo expresses optimism for continued U.S.-India cooperation on defense projects, as well as for improvements in the business climate; however, he is skeptical of the capacity of some Indian states to effectively implement social policies in the wake of the greater decentralization proposed by the BJP. Finally, he believes that the government’s growth and deficit goals are well within reach.

Prime Minister Modi’s government has explicitly staked its political fortunes on its capacity to improve India’s economic performance and make the country an easier place to do business. What are the most noteworthy ways this budget articulates the BJP’s vision for accomplishing these goals?

The first full budget of the Modi government is clearly growth-oriented with a focus on public investment-led infrastructure, tax rationalization, and measures to improve the ease of doing business. The intention of the government is to revive domestic investment and attract foreign investors so as to ensure that the “Make in India” initiative is a successful one for manufacturing-led job creation and growth.

One of the noteworthy aspects of the budget is its focus on infrastructure development, both in terms of allocation and policy measures. The 2015–16 budget allocates a whopping $79 billion to infrastructure investment (capital expenditure both by the government and public sector undertakings), compared with $57 billion in 2014–15. The budget has increased the allocation for roads and highways by $11.5 billion and provided $16.5 billion to build five ultra mega power projects, each with a capacity of four hundred megawatts or more. Additionally, $3.4 billion has been allocated to the National Investment and Infrastructure Fund. The computerization of ports and tax-free bonds for infrastructure are some additional measures, among many, that are meant to provide quality infrastructure to help reduce trade and transaction costs.

Doing business in India is not easy, as reflected by India’s rank of 142 out of 160 countries in the 2014 Global Competitiveness Index. The new budget proposed many measures to improve this situation. These include setting up an expert committee to eliminate multiple prior permissions; establishing an e-business portal, which will house fourteen regulatory permissions in one place; and committing to a unified goods and services tax by April 2016. Reducing corporate tax rates from 30% to 25% over the next four years, while phasing out tax concessions and exemptions, which lead to tax disputes, will make India’s tax rate comparable to its Asian peers and is intended to attract investors. The Modi government has also proposed a new bankruptcy law to allow an easier exit for investors, has deferred the General Anti-Avoidance Rule by two more years, and established new legal mechanisms for the early resolution of commercial disputes. These are all measures directed toward improving the business environment. Further, removing the regulatory distinction between foreign direct investment (FDI) and foreign portfolio investment (FPI), increasing FDI ceilings in a variety of sectors, and merging the Forward Markets Commission with the Security and Exchange Board of India are all meant to reduce multiplicity in administration and regulations and bring greater transparency to the business environment.

Were there any omissions that struck you as particularly surprising?

While there was no single big omission in the budget, there were a few surprises. One of them is the lack of emphasis and relatively small budgetary allocation for “smart cities,” an ambitious project of the Modi government aimed at constructing well-planned, sustainable urban environments. This is a departure from the previous budget, which provided greater funding to the initiative.

On the fiscal front, the government could have managed to achieve its deficit target of 3% by 2016–17 rather than deferring a year by taking steps to cut its present subsidy bill of $37 billion. There is also concern about the reduction in funding for rural development to provide basic housing and sanitation, which declined from $13.98 billion in 2014–15 to $13.25 billion in 2015–16, and for public health, which fell from $5.54 billion in 2014–15 to $5.53 billion in 2015–16. Given inflation and the continuing needs of India’s poor population, this is a significant decline in real terms. The Modi government believes that increasing states’ share of central taxes from 32% to 42% will enable them to prioritize their own developmental objectives, including rural development, and that an increase in tax exemptions for health insurance premiums will ensure that the private sector can meet India’s healthcare needs. However, underdeveloped states with poor governance will be negatively effected in the immediate future. India spends little more than 1% of its GDP on public health, compared with 3% in China and around 8% in the United States. Therefore, any cuts in healthcare allocations are not justifiable. A final omission worth highlighting is that the 2015–16 budget makes no big move toward green and clean energy, at least in terms of resource allocation.

In his speech before Parliament, Finance Minister Jaitley framed the budget as a “quantum leap,” as opposed to “incremental change.” Do you agree?

I don’t think there is anything in the budget to justify calling it a “quantum leap.” Certainly the budget is more focused on investment, growth, and improving the overall business environment, which was expected. The Modi government came to the power with an absolute majority by promoting an agenda built on economic development. There is progress in terms of the 2015–16 budget’s greater focus on investment-led growth compared with previous budgets, but certainly nothing that we can call a quantum leap.

What types of reform, then, would signify to you that there has been a more dramatic shift in policies? Are these reforms currently feasible or even desirable?

More than any big bang reforms, what is required is effective implementation of policies that are already announced. However, more dramatic reforms would have included raising the FDI ceiling in the defense sector to 51% or building a consensus among the states for a 51% FDI ceiling in multi-brand retail, which has thus far proved to be a great challenge. It also would have been nice to see renewed efforts to revive public-private partnerships and improve intellectual property rights regulations. Finally, I would hope to see the Modi government proactively work with states to cut down prior permissions for project implementation.

The Defense Trade and Technology Initiative (DTTI) continues to be a crucial element of the U.S.-India strategic partnership. After the decision last year to raise the FDI cap in the defense sector to 49%, are there any important takeaways from this year’s budget for the U.S.-India defense partnership?

The 2015–16 budget increased funding to the defense sector by 10% over last year to a total of $40 billion. This increased allocation and growing India-U.S. economic cooperation in recent years will likely mean more defense collaboration between the two countries. As Foreign Minister Jaitley mentioned in his budget speech, the government is working toward more transparent and quick decision-making in defense purchases, which would help U.S. firms supplying defense equipment to India. As the government has reduced taxes on technology royalties, Indian companies can have more technical collaboration with U.S. firms in the defense field. The increase in the cap on foreign ownership of defense projects to 49% in last year’s budget offered substantial commercial and investment opportunities to U.S. firms, though they would have preferred a full liberalization of the sector, or at least an increase in the foreign ownership cap on defense projects to 51%. It is likely, however, that the caps will be hiked further in the coming years. Additionally, the recently announced 2015–20 foreign trade policy provides a few new incentives to the defense sector to enable it to enhance exports. The objective is to move from being the world’s largest importer of defense equipment to exporting more military goods. I am confident that U.S. companies will be able to collaborate and play a significant role in this sector in the coming years.

Jaitley has set ambitious targets for reducing India’s budget deficit to 3% of GDP by 2017–18, while achieving an 8% growth rate by next year. Are these goals overly optimistic, and to what extent is the government’s new method for calculating growth inflating results?

The government will likely achieve the target of a 3 % fiscal deficit by 2017–18. Low crude oil prices, which have significantly reduced government oil subsidies, and strong resource mobilization via coal and spectrum auctions will help keep government finances in good health. Moreover, growth is expected to pick up and reach around 8% by 2017–18, which will enable the government, with better tax compliance, to generate revenues more effectively. Thus, I think a growth rate of 8% by 2017–18 is very possible.

The new method used by the Central Statistical Organisation to calculate GDP inflates figures by almost 0.5% of GDP. The new method has expanded the coverage of manufacturing and under-represented (unlisted and informal) sectors in its figures and includes corporate activities of approximately 500,000 manufacturing companies (whereas the old method included around 200,000). The unorganized and informal sectors (both agriculture and non-agriculture) are an important part of Indian economy, providing approximately 80% of the country’s total employment and contributing almost 50% of GDP. Therefore, the new method, which covers informal manufacturing firms, is a better reflection of reality. These revised numbers are acceptable if the government follows international standards, but the earnings and performance of strictly listed and formal companies don’t support these figures. Further, manufacturing data now includes selling and marketing expenses, whereas the old system only included production costs.

What are the biggest challenges confronting the Modi government as it works to implement its economic policies over the coming year? Are there any portions of the budget that will face particularly strong opposition in Parliament?

The biggest challenge to the Modi government is meeting the high expectations of the people. The public’s aspirations can only be met if policies are implemented quickly and in a transparent manner. This is complicated by the fact that India is a federal country, and the central government needs strong support from state governments when it comes to implementation. There were some discussion in Parliament on a variety of contentious issues. Although the BJP’s absolute majority in the lower house led to the easy passage of the budget proposals, the government had to work hard in the upper house, where it does not have a majority. This was particularly true on issues such as the 2015 land acquisition bill, which continues to face still opposition in the upper house.

This budget largely continues Congress Party policies when it comes to major welfare programs, although the Modi government does look to make big strides in direct cash transfers. What do you make of the efficacy of these programs? Given India’s ongoing struggle with poverty, how would you like to see the government tackle the issue?

The government has accepted the 14th Finance Commission’s recommendations to increase the tax devolution share for the states from 32% to 42%. In the process, the central government was forced to reduce plan transfers, particularly centrally sponsored schemes, which include grand social programs like the Mahatma Gandhi National Rural Employment Guarantee Act, and the Mid-day Meal Scheme. Given the importance and politically sensitive nature of some of these programs, which had been initiated by the previous Congress government, the Modi government could not afford to stop them. However, 8 out of the total 66 schemes have already witnessed a complete halt of central funding in the 2015–16 budget. Another 24 schemes will see reduced funding from the central government, and only 31 schemes will henceforth receive full funding. Although these programs are necessary, there must be greater efficiency in their delivery mechanisms. The Modi government has been working on this by making direct transfers to beneficiaries to reduce leakages and corruption. The level of fiscal autonomy provided to the states by the 14th Finance Commission and endorsed by the new government is a historic move, but it remains to be seen whether this autonomy is good or bad given that the states are at different levels of development. A critical question is whether less developed states possess the vision and governance institutions to take complete advantage of the fiscal autonomy and move forward.

Pravakar Sahoo is an Associate Professor at the Institute of Economic Growth (IEG) at Delhi University. The views expressed here are his own and do not reflect the position of the Institute of Economic Growth.

This interview was conducted by Louis Ritzinger, a Bridge Award Fellow at NBR.