For India: A “Balanced” Budget

On July 10 Indian Finance Minister Arun Jaitley released the government’s revised budget for the fiscal year 2015. There were two main components to today’s exercise: the budget itself, which is a specific legislative proposal before Parliament covering spending and taxation proposals, and the budget speech, which highlights the overall reforms planned by the government in the coming year.

The budget speech is typically viewed as the most important annual statement on government economic policy. It takes on increased importance this year, since it is the first detailed look at what the new Narendra Modi-led government plans to do to return India to a higher growth rate.

Q1:  What were the budget expectations ahead of its release? Were expectations met?

The finance ministry did not have the fiscal space to dramatically increase spending or to reduce taxes. The budget targets a fiscal deficit of 4.1% of GDP, down from 4.5% in fiscal 2014. This is more aggressive than many people had predicted. The previous government went on a dramatic spending spree during the election campaign—which included the first two months of the 2015 fiscal year—so a 4.1% target sounds like a stretch goal. As with so many other facets of life in India, everything will boil down to the government’s ability to follow through.

Among non-budgetary reforms previewed in the budget speech there is a bit more to cheer. Business hoped for greater rationality in how taxes are assessed and tax disputes handled. Adoption of a national goods & services tax has been shown through various studies as having the single biggest positive impact on GDP growth. Foreign investors were hoping for changes in foreign investment limits, particularly in insurance and defense. Each of these issues were noted prominently in the budget speech.

Q2: How about foreign investors? 

Over the last two year, short-sighted economic policymaking in India became a serious wedge in U.S. India relations. There were a few broad issues creating most of the dissonance: protection of intellectual property, particularly patents; tax treatment of foreign investors; imposition of local manufacturing mandates; and lack of progress on increasing foreign investment limits in certain sectors.

Today we saw a very mixed bag in terms of how these issues were handled. There was no mention of intellectual property. 

There were some hints that localization of manufacturing may be expanded, but primarily by using tax incentives for domestic production rather than new mandates. 

Cross-border taxation received a great deal of attention, with several new policies to help avoid lengthy tax disputes related to transfer pricing and related measures. However, investors had hoped for a stronger move on the other broad basket of tax concerns–the 2012 amendment to India’s Income Tax Act that allowed the finance ministry to retrospectively ignore tax treaties in favor of domestic tax law.  The Finance Minister did not revise this legislative change, nor did he announced a blanket withdrawal of cases which have arisen under this change. He did pledge to establish a “High Level Committee” in the Central Board of Direct Taxation (CBDT) to review retrospective tax cases before they are pursued. 

Lastly, on foreign investment caps, I believe the Finance Minister exceeded expectations by improving the rules for construction projects and by reiterating his commitment to lifting the foreign investment cap in the insurance sector. I believe the proposal to increase the foreign investment cap in defense to 49% may not attract many new investors, and hope when the actual rules are released there will be clear scope to invest above 49% in some sub-sectors. One other sector where a foreign investment cap relaxation was expected—business-to-consumer ecommerce—was not mentioned at all.  However, on this last point, there was one innovative proposal–to allow foreign companies that manufacture in India to sell their products via ecommerce.  Here again, potential investors will eagerly await the exact rules.

Q3: Which sectors were seen as the winners and losers?

Woven throughout the budget and budget speech, it is clear that the government’s overriding focus is to stimulate manufacturing and developing infrastructure.  Some of the sub-sectors in manufacturing that received special attention include televisions, electronics, renewable energy equipment production, garments, and food processing. 

Two particular product groups were targeted for tax increases: tobacco products and soft drinks.

Q4:  What has been the reaction in India?

India’s two main industry bodies—the Federation of Indian Chambers of Commerce & Industry, and Confederation of Indian Industry—had very positive things to say. These industry groups highlighted the government’s commitment to fiscal prudence, the inclusion of timelines and deadlines for many non-budgetary reforms, and better bankruptcy rules. Because many of the proposals noted above are not a part of the budget—but instead merely the Government’s plans for future reforms—other respondents prefer to withhold judgment until we begin to see tangible action.

The Congress Party, now in opposition, was less charitable. Congress President Sonia Gandhi responded that most of the BJP’s ideas were, in fact, Congress proposals in new packaging. The Congress Party’s leader in the lower house of Parliament, Mallikarjun Kharge, said the Budget focused on industry instead of the “common man.”Congress Party Vice President Rahul Gandhi said the budget has “no clear roadmap,” and compared it to a laundry list.

Markets did not react violently in either direction. The two main market indicators, the Sensex and Nifty, were both down nominally. Foreign institutional investment (FII) was net positive by $236 million, the fifth consecutive trading day that FII’s were net buyers, but the lowest daily total of the five days.

Richard Rossow is a senior fellow and Wadhwani Chair in U.S.-India Policy Studies at the Center for Strategic and International Studies (CSIS) in Washington, D.C.

Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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