Can Modi’s budget boost India’s economy?

Published on 16 July 2014 1 comments

By Anubhav Mohanty

Arun Jaitley, India’s Finance Minister presented the Modi-government’s first budget last week. In a speech that lasted a little more than two hours, the Finance Minister outlined his road map for the economy which included measures to improve infrastructure, reform the tax system and allow more foreign investment in the defence and insurance sectors. However, he stayed away from announcing any large-scale changes to the economy. This budget, he said, is only the beginning of a journey towards achieving 7%-8% annual GDP growth in the next 3-4 years.

State of the economy

The new government, which came to power following a landslide victory in the elections held in May, inherits a slowing economy afflicted by high inflation. In 2013-14 GDP grew by 4.7% while inflation was lower at 6% in 2013-14.

The Annual Economic Survey (AES), released by the government a day before the budget, presents a mixed but improving picture of the economy. The AES indicated that the economy was expected to expand by 5.4%-5.9% in 2014-15 – an improvement over previous years. While we think that the GDP growth target for 2014-15 is manageable, there is still a long way to go before long term growth rates can increase to 7%-8%. In our main economic scenario, we expect growth to be around 6.5% in the next 3-4 years.

Inflation, though declining, has remained above the government’s comfort zone, primarily driven by higher inflation in food products, and remains a major challenge for them.  We expect inflation close to 5.6% in 2014-15.

As we pointed out in the May edition of the Global Economy Watch, quick and decisive structural reforms are crucial to boost investment and medium-term growth. The latest AES highlighted several structural weaknesses including that of ageing infrastructure which the maiden budget seeks to address.

The twin deficits

IndiaBudget_TwinDeficitsChart

However, the challenge of rebuilding and improving infrastructure is made tougher in a state of high fiscal and current account deficits. In this budget, the government accepted the daunting challenge, set by the previous government, of bringing the fiscal deficit down from 4.5% in 2013-14 to 4.1% of GDP in 2014-15 and further down to 3.6% of GDP in 2015-16.  Similarly, the current account deficit is expected to be around 2.1% of GDP in 2014-15.

What’s in the budget for businesses in the UK?

The UK is one of the largest investors in India while India invests more in the UK than in the rest of the EU combined. The trade links between the two countries have been increasing in recent years. Since 2009, UK exports to India have increased by 50%, while imports from India have increased by a third. In a recent visit to India, Chancellor George Osborne met business and political leaders to promote economic cooperation between the two countries. During his visit, several new investment plans were announced.  Given the close links between the two economies, one of the important implications for UK business is how successful the Modi government is in stimulating growth, and the government’s maiden budget provides an indication of the future prospects for the economy.

Some of the key announcements of interest to businesses in the UK are as follows:

  • Retrospective taxes: Tax laws, especially the rules on retrospective tax, have been of concern to businesses and foreign investors in the country. The budget promised a stable tax environment. This budget does not abolish the rules on retrospective taxes but promises that the government will not ordinarily enforce retrospective taxes that create a new liability. The budget also establishes a more formal process for the initiation of inquiries on indirect transfer transactions.
  • Goods and Services Tax (GST): Previous governments have been trying to work out a largely uniform GST regime, and this budget aims to approve a GST by the end of this year.
  • Real estate and infrastructure investment trusts: To promote investment and employment in infrastructure and construction, the government will implement the required tax code changes to allow pass through status for both real estate investment trusts and infrastructure investment trusts. Further, to encourage the development of Smart Cities, foreign investors are now permitted to develop projects with relatively smaller sizes i.e. with a minimum built-up area of 20,000 square meters.
  • Manufacturing: Foreign-owned manufacturing units in India will be allowed to sell directly to consumers (“B2C sale”) including sales through electronic platforms without any additional approvals. The e-retailing market in India is expected to grow and existing manufacturers will be able to take advantage of this to reach a wider market without any further costs.
  • Foreign investment limits: This budget has also raised the limit on foreign investment in the defence and insurance sectors from 26% to 49%.
  • Tourism: The government plans to introduce e-visas, to facilitate the visa-on-arrival process, in nine Indian airports. This process will be introduced in phases for tourists from different countries.
  • Railways: In a separate budget for the railways, the government announced several investment programmes in partnership with private operators and also signalled the government’s intent to allow foreign investment in the sector. It also emphasised project completion over new projects being announced – a refreshing change from previous budgets.
  • Other transport infrastructure: The government has allocated close to Rs 37,000 crores (£3.7 bn) for investment in national and state highways, and also close to Rs 11,000 crores (£1.1 bn) for the development of ports.
  • Governance: With a view to improving governance, the government intends to integrate ministries through electronic platforms. These platforms are expected to increase the ease with which the businesses and individuals access government services.

In addition to the above, the government also announced several schemes to improve infrastructure in the agriculture sector, to improve manufacturing output and employment and to improve education and sanitation.

In summary, the new government’s maiden budget is realistic but it lacks the bold widespread reforms that were expected after the sweeping election victory. We hope this is because the government wants to focus on implementing and consolidating these reforms before introducing any major changes – a sensible strategy.

However, the reforms announced in this budget alone are not sufficient to enable the economy to meet its annual growth target of 7%-8% in the next 3-4 years; a lot more needs to be done, especially measures to improve manufacturing output and productivity.

Anubhav Mohanty
Read profile | Contact by email | Tel: +44 (0)20 7804 9972


«UK economy takes off – but it could still be a bumpy ride | Homepage | UK recovery remains on track – but no grounds for complacency »

Comments (1)

Terry Hopper commented:

Thanks for sharing this blog and post. I really like this.

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