Narendra Modi just cracked India’s economy open a tiny bit more

Change is coming.
Change is coming.
Image: Reuters/Adnan Abidi
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Minutes into his budget speech, India’s finance minister all but declared victory. “The credibility of the Indian economy has been re-established,” Arun Jaitley said. “The world is predicting that it is India’s chance to fly.”

The Narendra Modi government’s flightpath described in Jaitley’s 90-minute-long address will be a combination of big infrastructure spending, safeguards for the rural poor, and tax cuts for corporations.

And the big takeaway is that India is looking the other way on its fiscal deficit, instead choosing to drive growth in Asia’s third largest economy.

That’s partly because Modi’s honeymoon is over. After a landslide electoral victory on the promise of reviving India’s economy to what it was before the global financial crisis, the prime minister and his economic team have been criticised for making only piecemeal reforms.

After the recent hammering in the Delhi elections, where Modi’s Bharatiya Janata Party was resoundingly defeated by the upstart Aam Aadmi Party, the pressure on him to deliver has only grown. Indeed, India’s stock market, which rallied hard in the days before and after Modi’s victory last year, dropped sharply but closed higher on budget day than the previous day’s trading.

While his mandate has been to create jobs, open up the economy, and ease the pain of conducting business—Modi likes to talk of the 3S: speed, scale, and skill—the reality is that India’s government remains a dominant economic force. And that cannot change overnight.

And so at times yesterday, Jaitley—a stalwart in the right-leaning, free-market-espousing BJP—sounded a little too much like his predecessor, the Congress Party’s P. Chidambaram.

“Well-intentioned schemes introduced in the past, have often been ill-targeted, riddled with leakages and delivered with inefficiency. The same is true of subsidies. Subsidies are needed for the poor and those less well off,” he said. “What we need is a well targeted system of subsidy delivery. We need to cut subsidy leakages, not subsidies themselves.”

This budget has been much anticipated and hyped as the Modi government’s first rollout of policy initiatives that indicate just how he will lift India’s fortunes. Much of the 46-page document includes concerted moves to make India look more attractive to foreign investors. With the country’s debt-laden private sector unable to make the big investments the economy needs to get going, Jaitley needs international capital to flow in. And fast.

Yet, as in years past, the biggest push will still come from the government itself.


Modeled after Modi’s celebrated Gujarat model of development—where he, as the western state’s chief minister, spent heavily on infrastructure—the Indian government will an additional spend Rs70,000 crore ($11.35 billion) over last year to kickstart investments in the country’s infrastructure sector. In effect, infrastructure will now constitute about 14% of the Indian government’s total spending, compared to 11% last year.

The pressure seems necessary right now, especially since projects worth Rs8.8 lakh crore ($144 billion) have been delayed due to high rates of interest, infrastructure bottlenecks, and low domestic and external demand.

“It is no secret that the major slippage in the last decade has been on the infrastructure front,” Jaitley said. “There is a pressing need to increase public investment.”

The government, consequently, will increase spending by Rs14,031 crore ($2.27 billion) on roads and another Rs10,050 crore ($1.6 billion) on railways.

Plug and play

Even as he fights to push a controversial land acquisition law through Parliament, Modi is hawking another plan to lure private investors into the infrastructure sector.

After assuring clearances—typically a bugbear for industry—and linkages for coal and other resources, Jaitley will auction five new ultra mega power projects. Together, these will add 16,000 MW and unlock investments worth one lakh crore ($16 billion). The model that will be subsequently extended to other infrastructure projects such as roads, ports, rail lines, and airports—all sectors where regulatory clearances have been a persistent problem.

The Modi government will also revamp India’s public-private-partnership model—a similar plan was announced for the Indian railways—for sectors such as roads, power, airports and ports.

To pay for this, Jaitley will establish a National Investment and Infrastructure Fund, where the government will put in Rs20,000 crore, and provide leverage to infrastructure finance companies. Alongside, tax-free infrastructure bonds will be allowed in railways, road and irrigation sectors.

“The major issue involved is rebalancing of risk,” Jaitley explained. “In infrastructure projects, the sovereign will have to bear a major part of the risk without, of course, absorbing it entirely.”

Foreign investors

Aside from opening up the infrastructure sector, Jaitley’s other key move is to attract foreign money. India’s foreign direct investment (FDI) inflows grew 26% in 2014 reaching $35 billion, according to an UNCTAD report (pdf). In the rest of developing Asia, the growth was about 15% across 40 economies.

The budget has, for instance, proposed to eliminate distinction between different types of foreign investments. Foreign portfolio investments, which are investments in securities and other assets, and foreign direct investments, which are mainly controlling stakes in businesses. Overall, this means less of administration hassles.

There will also be a composite cap on the investments, which will allow foreign investors to invest more in Indian companies than their current limits. They can, for instance, invest up to 74% in private banks now, compared to the earlier cap of 49%.

Also significant is the implementation of the general anti-avoidance rule (GAAR), a retrospective taxation measure that ensnared multinationals and scared away potential investors. Telecom services provider Vodafone, for instance, was handed a bill of Rs20,000 crore ($3 billion) in a retrospective capital gains tax. Instead of scrapping the GAAR entirely, Jaitley has chosen only to defer it by two years.

Private equity

The finance minister has also allowed foreign investors to invest in Indian alternative investment funds (AIFs). The AIFs invest in non-traditional asset classes as opposed to stocks or bonds, the most common being private equity (PE) and venture capital.

This could be a potential game changer for PE, with both domestic and foreign investors now placed on a level playing field. That’s important because, stoked by India’s booming e-commerce companies, investors are pouring in money. In 2014, the total PE investment in India stood at about $10.9 billion, 50% higher than the year before.

Jaitley also proposed a tax pass-through for venture capital and private funds, where income generated would be taxed in hands of the investor and the fund wouldn’t have to shoulder the tax burden. With newfound clarity, expect venture capital and private equity funds to attract more investors.

Corporate tax

For domestic firms, the finance minister has proposed to lower the corporate tax to 25%, from 30% currently, but this will be spread over the next four years. Service tax, which is levied on everything from restaurants to advertisers, has been hiked from 12.5% to 14%.

Yet the finance minister drew short on the most anticipated tax reform for decades, the goods and services tax (GST). While industry largely expected him to provide a clear roadmap for the GST’s rollout, Jaitley only provided a date for its implementation: April 2016, a decade after it was first proposed.

The GST, once implemented, will bring different central and state taxes like the central excise tax, service tax and the value added tax under one umbrella, thus simplifying the tax structure for corporates.

“People who urge us to undertake big bang reforms, also say that the Indian economy is a giant super tanker, or an elephant,” Jaitley said toward the end of his budget speech, while emphasizing that the Modi has government had, in fact, moved with unusual swiftness.

Whether speed alone can steer India’s economy onto a higher growth path is the big question now.