India's 2011 Budget: 'Quietly Laying the Groundwork' for ReformsPublished: March 10, 2011 in India Knowledge@Wharton
Last year, when India's finance minister Pranab Mukherjee had presented his Budget for 2010-2011, he had sought the blessings of Hindu deity Indra -- the king of the gods, and more specifically, the god of the weather. He got the bountiful monsoons he wanted. This year, he added another deity to the proceedings. "I would pray to Goddess Lakshmi [the goddess of wealth and prosperity] as well," he told Parliament. "I think it is a good strategy to diversify one's risks."
Indra is essential: The Indian economy is still very dependent on the monsoons. Lakshmi is coming into her own: According to figures released by the Central Statistical Organization in Delhi in February, the economy will grow at 8.6% in 2010-2011, boosted principally by agriculture, which is likely to grow at 5.4% against just 0.4% in 2009-2010. Per capita income will rise 17.3% to US$1,200, which makes India a middle-income country, according to World Bank classifications.
According to the Capgemini-Merrill Lynch 2010 Asia-Pacific Wealth Report, India's HNWI (high net worth individual) population and its wealth grew 50.9% and 53.8% respectively in 2009. In absolute numbers, India is still low (with 126,000 HNWIs against China's 477,000). "Going forward, China and India are likely to remain the fastest-growing HNWI segments in the world," says the report. World Bank data shows that India will overtake China as the fastest-growing major economy in 2012, and the number of HNWIs is expected to increase.
Mukherjee's Budget did not cater much to these dollar millionaires, nor was it expected to. But surprisingly, it didn't offer much for the other end of the spectrum -- social sector spending. It was essentially a patchwork of proposals, none of them going far enough to set a tone for the Budget. "This is not a marquee budget, as the finance minister himself concedes in the speech," says Rajesh Chakrabarti, assistant professor of finance at the Hyderabad-based Indian School of Business (ISB). "But it is a good one, since it shows policy continuity in many areas and quietly begins the groundwork in many reforms, albeit in a gradualist manner." Adds New York-based Rajinder Sabherwal, who manages a macro fund called Magister Ludi Global: "The follow through on reforms and policy moves will be carefully watched."
Reform Measures Need a Push
Follow through will be urgently needed on several bills that have been stuck in the system for several years. The government does not have the numbers to push these through Parliament. But several opposition parties -- including the Bharatiya Janata Party -- support them in principle; they need to be wooed to support them on a case-by-case basis. Mukherjee specifically mentioned seven bills in the finance sector. They relate to insurance, pensions and banking. A couple of days after the Budget, the Union Cabinet approved the Banking Regulation (Amendment) Bill, which shows that the finance minister is not batting alone on the reforms front.
The other place where there has been some limited action is foreign investment. Foreign investors can now invest directly in mutual funds; it was earlier restricted to foreign institutional investors (FIIs). The FII limit for investment in corporate bonds has been hiked from US$5 billion to US$25 billion. But the big-ticket changes -- in retail and insurance, for instance -- were missing. There has long been a call to relax the foreign direct investment (FDI) limits in these sectors. An initiative on the controversial FDI in the retail sector (it will kill mom-and-pop stores, say the critics) was regarded as a certainty. Food inflation has been galloping. "The total food inflation declined from 20.2% in February 2010 to less than half at 9.3% in January 2011, but it still remains a concern," noted Mukherjee. FDI in retail is expected to filter down to the back end -- cold chains and logistics -- and reduce food prices. According to government figures, annual wastage in foodgrains is 10% and in horticulture 30%-40%, totalling up to US$18 billion.
But, again, Mukherjee may have sidestepped the issue to avoid another confrontation in Parliament. (This was one of the most peaceful Budget speeches ever, with hardly any interruptions from rambunctious members.) Just four days after the Budget, Mukherjee told a meeting of the Institute of International Finance in Delhi that discussions were underway to further liberalize the FDI regime. "There was not much expectation [of FDI in insurance and retail] going into the Budget this year," says Chakrabarti of ISB. "The expectation is there in the years to come."
Response from Foreign Investors
How have foreign investors reacted to this? Over the past couple of months, FII money has been pulling out, and the Bombay Stock Exchange Sensitive Index (Sensex) has tumbled from a high of more than 21,000 on November 5 to a closing of 17,823 on Budget day. (At one point that day, it had reached 18,296.)
"India has looked ungovernable and unattractive to foreign investors the past three to four months," says Sabherwal of Magister Ludi. "The budget is a step towards regaining the lost confidence. Our assessment is that India could regain its luster in the second half if it manages to wrestle down the key issues. We believe it will -- and foreign fund flows will follow." Nandan Chakraborty, managing director of institutional equity research at Enam Securities, points out that Mukherjee has promised a comprehensive FDI policy review. "He has implicitly committed to most of the reform agenda, without creating political controversy by mentioning some of them explicitly," he says. "The Budget has done what was in its control."
Mukherjee hasn't ruffled any feathers even on sensitive issues like public sector disinvestment. He has kept his target at US$8 billion, the same as last time. (The actual mobilization so far this year has been a little more than US$4 billion.) "The government is committed to retain at least 51% ownership and management control," Mukherjee assured the House.
A New Way to Subsidize
There was one announcement that could have huge implications for the long run. The government has decided to stop subsidizing kerosene and fertilizers and "move to a system towards direct transfer of cash subsidy to people living below the poverty line." A committee under Nandan Nilekani of the Unique ID project has been appointed to work out the modalities. It will take at least a year for the scheme to launch.
There were a few other odds and ends -- some dollops for education in the form of grants to specific institutes; US$100 million for the National Skill Development Council which has a mandate to create 150 million skilled workers by 2022 (it is running ahead of schedule, says Mukherjee); airfares will increase US$5 if you are travelling abroad and US$1 at home; and senior Senior Citizens -- those above 80 -- will be now known as Very Senior Citizens and be entitled to some tax concessions.
The Math Does Not Add Up
If the Budget was such a mild affair, why did the Sensex gyrate more than 600 points that day? (It went up 623 points the next day.) The answer lies in Mukherjee's numbers; many critics don't believe them. "The math does not add up," says Gaurav Dua, head of broking house Sharekhan. "The equities market was pleased with the government borrowing figure of US$75 million (against an expected US$85 million) and the aggressive fiscal deficit target of 4.6%, as against a target of 4.8% under the revised Fiscal Responsibility and Budget Management Act. However, the achievement of the stiff fiscal deficit target is based on the assumption of a fairly healthy 17.9% growth in the net tax revenues but a muted increase of just 3.4% in total expenditure. The growth in total expenditure has been managed through depressed provisions for subsidy expenditure (despite spiraling crude oil prices) and lower allocation for social services. Consequently, the Street would take the fiscal deficit target with a pinch of salt."
According to Chakraborty of Enam, oil will be a major variable: The Indian economy is hugely dependent on the price of crude as it imports most of its needs. Continued problems in Egypt and Libya could derail it.
"In the face of structurally high food and energy prices, the robustness of the growth and fiscal projections is questionable," says Sabherwal of Magister Ludi. "They don't provide comfort that India will be able to sustain a growth rate of 9%." Adds Chakrabarti of ISB: "Indeed, the estimates look a bit optimistic. But higher growth, raising revenues, could possibly make it happen."
Last year, the fiscal deficit was lower because of the US$15 billion collected through the auction of spectrum for 3G telecom services. There could be another bonanza from this sector as the government has been thinking of asking telecom firms to pay up for the 2G spectrum they received for a low price. (See India's 2G Telecom Scandal Spans the Spectrum of Abuse.) The government has already okayed the e-auction of FM radio licenses, which could bring US$500 million.
"Expect the budget speech to signal a more transparent way of doing business. At a basic level it means that you will see decisions increasingly being taken through auctions -- spectrum, mining rights, drilling permits, licenses, land and so on," wrote Amit Tandon, managing director of Fitch Ratings India, in The Wall Street Journal two days before the Budget.
"I see the Budget for 2011-2012 as a transition towards a more transparent and result-oriented economic management system in India," said Mukherjee in his speech. "At times, the biggest reforms are not the ones that make headlines, but the ones concerned with the details of governance."