Budget Is Key Test for India’s New Government

http://www.nytimes.com/2014/07/10/world/asia/budget-is-key-test-for-indias-new-government.html

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MUMBAI — As India’s newly elected government prepares its first national budget, the business community is watching whether Prime Minister Narendra Modi’s development-focused campaign promises translate into tangible economic reform.

The budget announcement lays out a road map for the next year and sets the tone for New Delhi’s economic policy making. For India’s stock markets, which have been buoyant since the sweeping victory in May of Mr. Modi and his Bharatiya Janata Party, the budget announcement is the next big event. The clear mandate given to the government offers both domestic and foreign investors reason to hope that Finance Minister Arun Jaitley will be willing to make tough calls to rescue the floundering economy.

On Wednesday, the government released its economic survey, which comes each year ahead of the budget. The survey predicted that India’s gross domestic product would increase 5.4 percent to 5.9 percent in the current fiscal year, which runs through next March, and would not reach 7 percent growth for at least another two years. Mr. Jaitley said at a news conference that the report “shows the gravity of the economic situation that needs correction.”

The government’s primary challenge will be managing the delicate balance between encouraging growth and constraining the deficit. The previous government’s interim budget, released earlier this year, set the annual deficit target at 4.1 percent of G.D.P., a figure that was widely criticized as unrealistically low. The survey report released Wednesday indicated that India’s fiscal situation is much bleaker than had been portrayed.

“The expectations from this budget are enormous,” said Soumya Kanti Ghosh, chief economic adviser at the State Bank of India, which is owned by the government. “The fiscal deficit number is not important because everyone knows it will be higher than 4.1 percent, but a pragmatic road map needs to be set for a credible amount of fiscal consolidation in the next few years.”

In its first significant policy announcement, the Modi administration released on Tuesday a railway budget that hinted that the government was open to private financing and foreign investment to pay for ambitious modernization plans.

“The fact that the railway minister spoke about project implementation and completion, and focused on ongoing projects, is a positive indication,” said Bidisha Ganguly, chief economist at the Confederation of Indian Industry. “However, there were no specifics about the financing of the railways, which are currently in extremely bad shape.”

Domestic and foreign investors are hopeful that the federal budget announcement will bring some clarity on taxes. “The government needs to do away with retrospective taxation” — taxing transactions after the fact — “as it has distanced investors from India and created a lot of concern and ambiguity related to tax liability,” said Dhanpal Jhaveri, chief executive of Everstone Capital Advisers, a private equity firm.

Investors want a schedule for the implementation of the goods and services tax, which will replace direct taxes levied by the central and state governments and is expected to reduce logistical costs substantially.

Investors are also concerned about the nature of anti-tax-avoidance rules being considered by the government.

Girish Vanvari, co-head of tax at the consulting firm KPMG India said, “The government needs to create an ecosystem to make India a safe investment jurisdiction.”

Industrial company leaders are hoping the government will step up capital spending on infrastructure projects to enhance growth. “We are looking for increased budgetary allocations for infrastructure spending, announcements on new projects and tax concessions for infrastructure spending,” said Ms. Ganguly of the Confederation of Indian Industry.

One of the ways the government is expected to raise money to offset infrastructure spending is to privatize, or sell stakes in, government-owned companies.

“Looking at the subdued growth numbers, the chance of any major improvement in tax collection is remote. So the only avenue at the moment to bridge the fiscal deficit gap is aggressive privatization,” said Amisha Vora, joint managing director at Prabhudas Lilladher Group, a brokerage in Mumbai. “There are a lot of public-sector companies that are almost defunct and left with only assets, where the business has not been existing for some time now. How to get rid of those assets and realize cash will also be an important area to unlock capital.”

India’s enormous subsidy bill, now about 2 percent of G.D.P, is one area that is likely to be tempered by political considerations. While subsidies on fuel, transportation and food add a substantial amount to the country’s annual spending, any effort to tinker with them leads to immediate political backlash. When the new government attempted to raise rail fares, the public reacted negatively, and some of the increases were rolled back.

“The government has continued with the increase in petrol and diesel prices, and has also increased fares on both freight and passenger trains, which suggests that they will be taking a more pragmatic approach,” Ms. Vora said. “However, there might be a drought situation in India this monsoon, because of which rural income will be under constraint, so the more aggressive steps of price increases and subsidy cuts might be kept for the next budget.”

Analysts predict that the government will be prepared to take calculated political risks before the coming state elections.

“The B.J.P. is also conscious of not upsetting the apple cart in critical states like Haryana and Maharashtra, where elections are coming up soon and the party is poised to do well,” said Milan Vaishnav, an analyst at the Carnegie Endowment for International Peace, a Washington-based research center. “The government is likely to calibrate reforms to fit its timeline, rather than proceed hastily in a big-bang fashion.”

He added that the government would be particularly cautious in tinkering with prices that would directly affect consumers’ bottom line.

Yet economists are hoping that economics wins out over politics in the national budget.

“The government should not involve itself in mindless populism, because ultimately that populism creates a burden for future generations,” said Mr. Ghosh, the State Bank of India adviser.