Budget 2009 Arrives … Not with a Bang But a WhimperPublished: July 16, 2009 in India Knowledge@Wharton
For a few weeks before July 6, the day Finance Minister Pranab Mukherjee unveiled the Union Budget, TV channel CNBC bombarded viewers with ads about its special programming for what it called "The Big B". After the Congress-led government was voted back to power in the recent general elections, much was expected on the reform front. This was supposed to be a Big-Bang Budget, what with the government no longer having to rely on the Left for support.
It turned out to be a whimper rather than a bang. "The Big Bore," said a headline in The Times of India. "Smaller sops, smaller reforms; FM chooses muddle path," wrote the Daily News & Analysis (DNA). This newspaper's Budget edition was an example of the disappointment. Its inside pages were full of large pictures of masterpieces – the Thinker, the Mona Lisa … They were obviously meant to be complemented by "masterpieces" from Mukherjee's Budget. The editors were unwilling to jettison this long and elaborate preparation. But they couldn't find a single comparable offering from Mukherjee. "This was not a budget with any Viagra," says Ajit Dayal, director of Quantum Asset Management, a mutual fund house.
Of course, Mukherjee didn't have too many options, what with the huge spending needed to cope with the impact of the global slowdown. But there is another school of thought. The budget was bland, save for large dollops of sops for rural India (see companion story). But the reformist intentions may have been camouflaged. Wrote economist Omkar Goswami in the Hindustan Times: "Mukherjee is much like his muse Kautilya -- canny, clever and pragmatic. He covered his tracks quite well by saying, 'Members would appreciate that a single Budget Speech cannot solve all our problems, nor is the Union Budget the only instrument to do so.' That's why he didn't speak about increasing the FDI (foreign direct investment) limit on insurance to 49%. That's why he didn't announce sweeping tax reforms. That's why he didn't set the Yamuna on fire. And that's why I believe that Union Budget was a tactical yawn. Time will tell whether this was tactical or just a plain, boring yawn."
Jagmohan Singh Raju, a professor of marketing at Wharton, points out that in his view the budget will have a positive impact on the economy. "I do not think the budget sends any wrong signals. A strong stable India with a greater buying power that is evenly spread will make the country more attractive for global investment. It will also allow India to make strategic global investments of its own. India's growth now requires both."Saikat Chaudhuri, who teaches management at Wharton, found Banerjee's performance with the Railway budget impressive. "She did something that works for her political ambitions but is also good for the economy," he says.
Disinvestment in Public Enterprises
Ten days after the budget, the former is beginning to look more likely. One of the big things that was expected from Mukherjee was some pronouncement on public sector disinvestment. The Economic Survey, which is released by the government a couple of days before the budget, had hinted that this might happen. The Survey was tabled in Parliament by Mukherjee himself. On disinvestment, it had said the government should:
- Revitalize the program and plan to generate at least $5 billion a year.
- Complete the process of selling 5% to 10% equity in previously identified profit-making non-navratnas. (The navratnas are public sector undertakings – PSUs – identified by the government as being highly successful. They are given a greater degree of operational freedom.)
- List all unlisted PSUs and sell a minimum of 10% of equity to the public.
In his budget speech, however, Mukherjee said "public sector enterprises such as banks and insurance companies will remain in the public sector". He pegged the disinvestment target at just $200 million. The stock markets, which were banking on disinvestment as a sentiment booster, were not amused. On the day of the budget, the Bombay Stock Exchange Sensex was down 870 points or 8%.
Yet even before the budget week was out, Power Secretary H.S. Brahma announced that NHPC (formerly the National Hydroelectric Power Corporation) would come out with a $350 million issue in August. The Oil India issue is scheduled for September and several others are waiting in line. So what's the niggardly $200 million all about?
There is speculation in the media that the budget number was merely to hoodwink the Left and other anti-reform sections. Under current norms, all disinvestments proceeds go to the National Investment Fund (NIF). This was set up under Left pressure and can only be utilized for specific purposes. "The government is considering a plan to dismantle the NIF," says the Hindustan Times. If it can get this through, the disinvestment proceeds can be used to reduce the fiscal deficit.
There is some indication that this may indeed be the government's thinking. Tucked away in the budget speech is this statement: "The average public float in Indian listed companies is less than 15%. Deep non-manipulable markets require larger and diversified public shareholdings. This requirement should be uniformly applied to the private sector as well as listed public sector companies. I propose to raise, in a phased manner, the threshold for non-promoter public shareholding for all listed companies." Initially, observers felt that this was targeted at people like Azim Premji, who owns more than 80% of Wipro. They now think that Mukherjee may have been talking about PSUs. "I think this is a budget which will take two-to-three days for the larger market, not just the capital market, to understand and then probably react to," says ICICI Bank chairman K.V. Kamath.
Yet, on PSUs, it may not be so easy. Congress ally Trinamool Congress, led by Railway Minister Mamata Banerjee, has already come out strongly against this privatization. "The Trinamool leader, with her total focus on the 2011 West Bengal assembly elections, is dead set against any policy that is not populist," says The Times of India.
The fiscal deficit has to be bridged, and the money raised from privatization is a quick-fix solution. There is already alarm about how Mukherjee will balance his books. "The fiscal deficit of 6.8% definitely looks high," says Sujit Sircar, CFO of IT company iGATE. "More concerning is that there is no mention of when the trend might see a reversal." Adds Godrej Group chairman Adi Godrej: "On the fiscal deficit issue, I think the finance minister has done the right thing by saying that he will bring a balance as and when the economy recovers, but I was disappointed that he did not indicate the money to be raised via disinvestment to bridge the fiscal deficit."
A post-budget analysis by research house Angel Broking elaborates on the issue. "The finance minister defended the high fiscal deficit position, which increased from 2.7% of GDP in financial year (FY) 2008 to 6.2% of GDP in FY2009. The difference between the two constituted the total fiscal stimulus at 3.5% of GDP, which helped the Indian economy find stability in the backdrop of a highly weakening external environment. On the fiscal deficit front, the finance minister did not lay much emphasis apart from acknowledging the fact that it is important to 'return to the FRBM (fiscal responsibility and budget management) target for fiscal deficit at the earliest'. The fiscal deficit is expected to be at 6.8% in FY2010. Combined with the state deficit, it is likely to be over 10%. We would like to reiterate here that we believe a fiscal deficit of 10% plus is a setback, albeit temporary, in the fiscal consolidation of the past few years. But in the context of the GDP slowdown facing the economy, this is not a large amount at all."
This has other implications. To fund this fiscal deficit, the government plans to borrow nearly $80 billion from the markets during 2009-10, an increase of some 50% over the previous year. This may crowd out borrowing by the private sector and lead to an increase in interest rates. This is obviously not good for either companies or individuals. "Financing of the government's programs without distorting market interest rates remains a key challenge to be addressed," says ICICI Bank CEO and managing director Chanda Kochhar.
HDFC chairman Deepak Parekh has a different perspective. "There is sufficient liquidity so far in the market," he says. "I don't think interest rates are going to harden that much, at least in the next three to four months. The government borrowing program is over a longer period of time and the finance minister did say he would work with the RBI (Reserve Bank of India) and find a way to minimize the borrowing."
Parag Saxena, CEO of New Silk Route, an investment firm in New York City, says he is less concerned about the deficit than about how "India is going to pay for it – and the lack of announcements about that issue. If that explanation had been included – and these issues have been addressed in speeches by individual ministers – then we would not have seen the same sell-off in the financial and currency markets which gave their knee jerk response after the budget." Saxena argues that if the government is willing to sell off parts of public sector enterprises such as Air India, the Oil and Natural Gas Commission, etc., then "there should have been some comment about it at this point in time, simply because it is directly related to the fiscal deficit."
The good news from the budget is that Mukherjee knows where he needs to go. "The first challenge is to lead the economy back to the high GDP growth rate of 9% per annum at the earliest," he said in his speech. According to Kochhar of ICICI Bank, "the growth target of 9% set by the Union Budget is clearly a positive signal, especially given the backdrop of weak macroeconomic conditions globally. The budget seeks to provide a contra-cyclical fiscal stimulus to facilitate this growth."
The other good news -- from the Economic Survey -- is that Mukherjee seems to be equally aware of how he should get there. consider some of the points in the Survey, which is essentially a wish-list prepared by the finance ministry:
- Reform of petroleum, fertilizer and food subsidies to reduce leakages and ensure targeting.
- Auction of 3G spectrum. The auctioned spectrum must be freely tradable, with capital gains on spectrum to be taxed under the Income Tax Act.
- Introduction of the new income-tax code that results in a neutral corporate tax regime.
- Review and phasing out of surcharges, cesses and transaction taxes (such as commodities transaction tax, securities transaction tax and Fringe Benefit Tax).
- Raising foreign equity share in insurance to 49%. In addition, consider allowing 100% foreign equity in a special category of insurance companies that provide all types of insurance (health, weather) to rural residents and for all agricultural-related activities, including agro-processing. This may help dispel fears of foreign equity in insurance.
- Allowing foreign direct investment (FDI) in multi-format retail.
- Raising FDI limit in defense industries to 49% (from 26%); allowing up to 100% FDI, on a case-by-case basis, in high technology, strategic defense goods.
This is only a small sampler of the recommendations made in the Economic Survey. Little wonder that the immediate reaction to the budget was widespread disappointment. Talking to television news channel NDTV, Y.M. Deosthalee, CFO of engineering giant Larsen & Toubro, said: "The budget lacks in three areas: It does not talk about governance, it does not talk about accountability and it does not mention the reform process." Added Ajit Gulabchand, chairman of Hindustan Construction Company: "As this is the first policy statement that the new government is making, we had expected more."
Saxena of New Silk Route notes that the government may have missed an opportunity, in this budget, to launch an initiative that would lead to the creation of an efficient debt market in India. "India needs a deep, broad debt market … and the fact that it does not exist imposes a cost on every citizen. The rural farmer who wants to buy a tractor or a farm of a reasonable size is losing because the cost of money he has to pay is unreasonably high – because India does not have a local debt market. If we made it efficient for people with surplus cash and a desire to invest in fixed income securities – and we had an efficient market for them to meet with people who could utilize that money in production -- then we would be in much better shape. That would happen, in my view, because the cost of debt would come down by hundreds of basis points. This is very material; it's not something at the edge. This is a big project – and it has the attention of the central government, for sure." Saxena adds that in order for such a debt market to come into being, clear bankruptcy laws and enforcement of contracts are essential conditions.
Such changes could still come about. As Kamal Nath, union minister of surface transport and highways, recently said: "We do not need a budget to announce everything."