Will The Modi Govt Deliver? An Analysis Of India’s Pre-Budget Expectations.

The new pro-business Indian government, led by Narendra Modi, is set to make public it’s first complete budget for fiscal 2015-16 on the 28th of February, 2015. Investors across the board have been betting big on the Modi government to stimulate investment and economic development and it is expected that the first full-fledged Union Budget FY 2015-16 will comprehensively address all pillars of the Indian economic growth story.

Generally, it is expected that there will be relief in various Income Tax slabs and other tax concessions, particularly incentives like raising the exemption limit under 80C to improve domestic savings from the current 30% and channelizing household savings towards infrastructure financing. Creating a separate tax slab for investment in insurance products will help the Insurance industry grow and meet long term financing needs. Introduction of instruments like ‘Kisan Vikas Patra’ can help raise savings from rural households.

Clarity on GAAR and retrospective taxation along with a definite timeline for quick implementation of GST will build investor confidence. To attract foreign investment FDI limits for non-strategic industries should be increased to at least 51% and the resource allocation process should be made more transparent. Focus on improving credit growth and a time bound capitalization plan for PSU banks should be prioritized.

Higher allocation toward infrastructure and promotion of projects under ‘Make in India’, ‘Smart Cities’, REITs and InvITs is expected. The government should create a non-bank, cheaper credit facility for smaller infrastructure players. Housing should be given infrastructure status, guided by the vision of ‘Housing for all by 2022’, and social infrastructure should be given increased budget allocation.

The Government’s commitment to fiscal consolidation and long term reform will be under scrutiny. Many expect the FY15 fiscal deficit target of 4.1% to be met and project 3.6% for FY16. Fall in crude oil prices, recent hikes in excise tax and the direct benefit transfer scheme may provide large savings from subsidy allocation and enough fiscal space for the government to stimulate public expenditure. Reforms will likely focus on expenditure efficiency. A clear roadmap for divestment over the next few years should be drawn to bring down government holding in PSUs to 51%. Non-tax revenue sources like divestments and coal auctions should be tapped throughout the year rather than at the end of each year. Well thought out amnesty schemes to bring back black money and prevent it from going abroad can improve India’s fiscal health

Drop in the Wholesale Prices Index (WPI) for January 2015 to a negative figure of -0.39 suggests that the persistent inflation has eased. The fall in core inflation (non-food manufacturing inflation) 0.9 percent from 1.5 percent in December also suggests the same. It also indicates that the manufacturing sector has lost a lot of pricing power. However, using the new Consumer Prices Index (NYSEARCA:CPI), inflation rose to 5.11 percent in the first week of February from 4.28 percent in December. The 5.5 percent gap between the two (5.11 percent for CPI and -0.39 percent for WPI) indicates a huge inefficiency built into the economy and immense loss of value in reaching products from factory to consumer. This can only be remedied by eliminating inter-state market barriers and improving the supply chain. The goods and service tax (NYSEMKT:GST) will eliminate some of these inefficiencies and bring more tax revenues, but more attention needs to be paid to creating a single national market for all goods and services.

Since Reserve Bank Governor Raghuram Rajan looks more at CPI than WPI for deciding interest rates, he will probably discount the negative WPI. So no rate cuts are likely before April. The Budget is expected to continue addressing supply side issues plaguing food inflation by increasing allocation towards agriculture and warehousing. Fiscal steps should be aligned with monetary measures to achieve RBI’s CPI inflation target of 6% in the short term and 4% (+/-2%) in medium term. However, fiscal measures should be more inclined towards growth and will focus more on the WPI suggesting a weak economy.

There is an expectation that Union Budget for 2015-16 will mark a seminal shift by freeing up funds to the tune of almost Rs 3 lakh crore and allowing states the flexibility to spend the resources given their priorities. This is expected to be done by axing centrally sponsored schemes (NYSE:CSS) which will be restricted to a handful.

As much as 85 per cent of the total Rs 5.75 lakh crore of the current Plan Budget is tied to various schemes that are conceived by the central government while the other component, block grants, where states have full flexibility, constitutes just 15 per cent of the total Plan funds. Apart from the resources used for Central sponsored schemes, 41 per cent of the plan funds are allocated to central sector schemes. These funds are allocated to 70 central ministries and departments and implemented by them. Again, states cannot spend these resources for any other purpose.

The dismantling of the Planning Commission and its replacement by NITI Aayog which focuses more on policy, has largely rendered redundant the old regime of central fund releases for states. Further, the Fourteenth Finance Commission has proposed a 42 per cent share for states in central gross tax revenues up from the current 32 per cent level and less control of the central government on fiscal transfers to states.

Revisions to India’s economic output data, due to a change in the method of measuring economic activity, mean that the upcoming budget should assume that the economy will grow by at least 8 percent in the 2015/16 fiscal year, a government source told Reuters on Tuesday, 10th Feb.

After the defeat of BJP in Delhi elections, some expect that this budget to be a slightly populist one. Also, the Finance minister, Mr. Arun Jaitely has been making statements in the media that he wants to encourage consumption to stimulate growth by leaving more money in the hands of middle class. For salaried class taxpayers, increased deductions under 80 C, in addition to reduced tax rates across tax slabs and increase in the minimum exemption limit is the expectation. Given rising healthcare costs they are also looking for increased exemption limits for health insurance under 80 D from current limit of Rs.15,000. Let us see whether or not the Union Budget will be able to appease the masses and give them what they want.

How many of these wide ranging expectations the Union Budget will be able to meet is a question which can be answered only on the 28th of February, 2015. For now, the overall de facto sentiments seems positive. Let us hope for the best.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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