Asia Economy

Modi budgets for Indian growth, to curb deficit

India Finance Minister Arun Jaitley with Minister of State for Finance, Nirmala Sitharaman and officials while giving final touches to the Annual Budget 2014-15.
Virendra Singh | Hindustan Times | Getty Images

Indian Prime Minister Narendra Modi's new government on Thursday unveiled a first budget of structural reforms aimed at reviving growth, winning praise from investors despite a lack of clarity over how he would cap the big fiscal deficit.

Expectations had been high that the government would utilise India's strongest election mandate in 30 years to take radical steps comparable to the 1991 market reforms that unleashed an era of high economic growth.

But in a bid to halt a two-year spell of weak growth, the government instead announced incremental steps to boost capital spending in Asia's third largest economy and reassure foreign investors that they would get fair treatment.

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"We shall leave no stone unturned in creating a vibrant and strong India,"Finance Minister Arun Jaitley told parliament, vowing to raise the pace of economic growth to 7-8 percent in three to four years from less than 5 percent now.

Jaitley, 61, told lawmakers he would uphold the fiscal deficit target for this year inherited from the last government - 4.1 percent of gross domestic product - despite expectations he would be forced to raise it due to weak revenue and high subsidy costs.

Ratings agency Moody's said a lack of detail on how India would cut the fiscal gap made it "challenging to assess the credit impact" of Jaitley's budget, but still said it would keep its investment grade rating for India

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Jaitley announced an 8 percent rise in spending, roughly unchanged after taking inflation into account. The government will also seek to raise a record $13 billion from selling state assets - nearly four times what the previous government raised in the fiscal year ended in March 2014.

What India needs to address in its budget
What India needs to address in its budget

India's budget, an act of theatre concentrating decisions that in other countries are spread over months, was delayed by a general election in May that handed Modi's Bharatiya Janata Party (BJP) a landslide victory.

Delivering the second half of his two-and-a-quarter hour address seated, Jaitley raised the minimum income level at which people start paying tax and hiked levies on cigarettes and soft drinks.

Investor friendly?

Jaitley announced he would raise ceilings on foreign investment in the defence and insurance sectors, but still bar non-residents from taking majority control in projects to supply the world's largest arms buyer.

Limits on foreign investment in defence and insurance ventures will go up to 49 percent from 26 percent - still less than sought by foreign contractors to justify sharing technology when they locate operations in India.

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In another signature initiative, the government will launch a tax reform this year to unify India's 29 federal states into a common market, a measure that would boost revenue while making it easier to do business.

Investors have piled into Indian stocks on hopes that Modi's leadership and mandate would break a logjam thwarting a host of reforms during the 10-year tenure of his predecessor Manmohan Singh, whose coalition government became increasingly divided.

While the concrete measures announced by Jaitley fell short of the most bullish expectations, Indian stocks and bonds finished a volatile day stronger, thanks to his commitment to fiscal probity.

"These measures are very progressive and good for the bond and equity markets," said Murthy Nagarajan, head of fixed income at Quantum AMC in Mumbai. "It would lead to a reduction of inflation in the coming years due to a lower fiscal deficit."

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'Bitter medicine'

Modi, 63, won election with a pledge to create jobs for the 1 million people who enter India's workforce every month. Since taking office, he has warned that Indians should expect "bitter medicine".

Reflecting that change in tone, Jaitley vowed to adhere to this year's "daunting" 4.1 percent budget deficit set by the previous government.

"I have decided to accept this challenge - one fails when one stops trying,"Jaitley told the lower house of parliament. He said the budget deficit would be reduced to 3.6 percent in the following two fiscal years.

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With the deficit already approaching half of the annual target just three months into the fiscal year, many economists had expected Jaitley to raise the borrowing target to 4.4 percent.

Jaitley managed to find room in the budget to fund projects to upgrade India's food distribution infrastructure. He raised subsidies on fertilisers and, against expectations of a reduction, extended diesel subsidies – key measures to aid farmers who face poor monsoon rains this year.

Investor protection

The minister said he would set up a high-level committee to review retrospective tax claims blamed for choking off foreign investment after companies such as Britain's Vodafone were hit with massive demands.

Vodafone and India have been locked in a $2.2 billion tax standoff since the British company acquired Hutchison Whampoa's Indian mobile assets in2007.

Vodafone, the world's second-largest mobile operator, thought it had finally secured victory in the case in 2012, when India's Supreme Court dismissed the tax demand. But the government responded by announcing retrospective legislation that would change the rules.

Jaitley sought to reassure investors by promising a stable tax regime and saying the government would not "ordinarily" create new liabilities retrospectively, but stopped short of moving to scrap the law. Several cases in the court will be concluded through the legal process, he said.