India’s ballot-box budget

There is something for all sections of the society in the budget and expectedly so. With the polls looming large it is futile to blame Chdambaram for presenting a populist budget but few were expecting the measures that he proposes for addressing the social and economic concerns. The Sensex might have plunged but the fact remains it is good for the industry and general growth.

by INDRAJIT BASU

No one doubted that what will probably be Finance Minister Palaniappan Chidambaram’s last budget before India’s ruling United Progressive Alliance government goes to the polls would be a populist one. Even so, a more-than-expected dose of populism was mixed with some sensible measures that addressed social concerns, and according to the minister, “will stimulate economic growth as well”.

The ruling coalition, run by the Congress party and supported by the Left, faces nine state polls this year besides general elections by May 2009.

An unprecedented level of social welfare, tax and manufacturing-directed measures wooed the poor, the middle class and industry. A debt waiver was granted to farmers, the tax free level of income was raised and local duties were cut across a wide section of manufactured goods, including small cars, while government spending targeting women, children and minorities was increased. The stock market was unimpressed, declining to accept Chidambaram’s claim that “this budget will stimulate investment and [economic] growth, which at 8.8% is not a joke, and will create wealth.”

The benchmark Bombay Stock Exchange Sensitive Index (or Sensex) plunged by more than 500 points as Chidambaram announced a 5% increase (from 10%) in short-term capital gains tax on the sale of shares held for less than 12 months. A 246-point recovery before the close was a brief interlude before the Sensex slid by over 542 points on opening trade on Monday, a fall also reflecting global economic concerns as the US economic outlook worsened.

Of particular concern to India’s investors was the budget waiver of US$15 billion worth of loans to farmers, a huge bank of voters.

The fiscal deficit, or increase of government’s expenditure over income - a problem plaguing the investment community for decades - “may actually increase due to spending increases in the budget, wage pressures, [and] uncertainty on who will be funding the debt waiver to farmers,” said Tushar Poddar, vice-president, Asia Economic Research of Goldman Sachs, while waiting to see the fine print on the budget numbers.

Standard & Poor’s said that while the budget assumes a fiscal deficit of 2.5% of gross domestic product (GDP) for the year ending March 31, 2009, compared with the 3.1% deficit in fiscal 2007-08, the actual deficit could bloat to 6.7% of GDP in the coming 12 months.

Even so, many of the lower paid will not be complaining. The $15 billion loan waiver and increase of the income tax exemption limit from $2,500 to $ 3,750 a year will mean that over 40 million farmers will not have to repay their loans and more than 20 million Indians will save up to $1,100 in income tax per year.

Their backing could be crucial for the Congress party which is kept in power by the 61 seats in the 543-seat Parliament held by the communist CPI-M-led Left Front.

The burden of farmer’s loans has been a major and sensitive issue in India, increasingly brought to public notice with the suicides of 4,000 farmers since 2004 after failing to pay off their debt. CPI-M in particular had been planning its next election manifesto around this issue. Clearly the Congress has taken the wind out of their sales announcing the loan waiver.

Left out this time that after a decade of hand-holding through tax breaks and export incentives is the country’s $64 billion-revenue information technology industry. Companies such as Tata Consultancy Services and Infosys Technologies were looking for measures that would help them grapple with increasing costs, the specter of a global slowdown in IT spending, and a depreciating dollar. The Indian currency appreciated 12.8% against the US dollar last year, undermining earnings in the sector, which gets more than 60% of revenues from the US.

It looks as if “the Finance Minister forgot we exist”, said Raman Roy, widely regarded as the pioneer of the IT-enabled services business in India, who also played a pivotal role in making India a hub for remote processing.

The opposite may be the case. Chidambaram imposed a higher import duty of 12% packaged software and brought customized software under the service tax net. The government did pledge to improve broadband access at 6,000 model schools, and make provisions for setting up 16 central universities and three technology institutes, in a move to improve the supply of skilled workers and thus “from a long-term view, focuses on the supply-side challenges restraining India’s competitive edge”, said Vineet Nayar, chief executive of HCL Technologies, an Indian IT company.

For the corporate sector, the absence of any news was good news - the budget kept corporate taxes and most other levies largely untouched. According to the Confederation of Indian Industry (CII), the country’s leading industry association, the reduction of manufacturing duties and income taxes “are steps in the right direction” that will indirectly benefit industry by spurring consumption.

The budget had virtually nothing for foreign and non-resident Indian investors, other than removing capital gains tax on conversion from foreign currency exchangeable bonds (called FCEB) to equity shares by Indian companies.

The absence of significant reforms and the scale of largesse in the garb of social welfare, meant the budget will “have a multiplier effect and stimulate the economy,” according to Chidambaram.

About 76% of chief executives polled by CII believed the budget focused on inclusive and sustainable growth, although 58 % said it lacked in reform orientation. A similar survey by PricewaterhouseCoopers found 55% of respondents believed the budget did not take any “meaningful steps to promote growth”, while 95% said it did not address the issue of promoting infrastructure, on which depends future economic growth.

Given the political context of the forthcoming elections] the budget basically addressed domestic consumption while keeping intact the governments’ reformist agenda intact, said Frank Hancock, managing director, ABN AMRO Asia Corporate Finance.

“Overall, it will be viewed as neutral to positive by investors,” he said. “The fact that there were no easy sops on corporate and personal income tax rates should not be a problem for anyone as these are already broadly in line with South East Asia. Consumers will continue to spend, and corporate India has benefited, at least some sections [like banks, automobile, and consumer goods companies]. I think that the government has got that balance broadly right.”