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Reforms expected – Will the Narendra Modi government deliver?
July 6, 2014, 12:30 pm
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Financial markets have built a lot of expectations on the Narendra Modi government’s upcoming budget on the 10th of July. The enormity of the election victory has given investors hope that the government will rehash regulations that have prevented business growth in the country, even in a context of high fiscal deficit and stubborn inflation.

Approximately 46% of the total fiscal deficit budgeted for fiscal year 2015 (April 2014 – March 2015) in the February interim budget has already been utilised in just April and May alone. This demands a tightrope leash that the government needs to maintain on the spending front, leaving little scope for any misdirected populist measures. That said, the government could utilise the disinvestment route to beef up its reserves by selling its stake in public sector enterprises.

Besides, the economy is tussling with high inflation levels (of ~8%CPI), which has kept the central bank hand-cuffed. Therefore, low interest rates are not considered, at least in the short term. 

This leaves the government with limited possibilities, mostly in the form of reforms on the supply-side, i.e. measures that will facilitate doing business by cutting down on the regulatory slacks. The market will be watching out for these measures in the upcoming budget. It is willing to give a long rope to the government on the fiscal deficit front because the government has inherited a weak economy from the previous government.

We believe the market will be forgiving if the fiscal deficit estimate is revised a tad bit higher, up to ~4.5%, from the 4.1% level projected in the interim budget in February. However, it will be intolerant to any kind of impediments on the reforms front.

On the reforms front, there are quite a few items which are expected to be a part of the budget speech. Power sector reforms which remove coal and gas supply hurdles, open up the coal sector for private players and strengthen the distribution companies financially are much anticipated. Also, progress on the oil and gas reforms which reduce the subsidy burden on the exchequer through price increases in gas, LPG, kerosene prices is awaited.

Rationalisation of the tax structure which avoids retrospective application of tax laws and progress on the much touted “goods and services tax” (GST) will be watched out for. Easing of FDI (foreign direct investment) limits is in the works across multiple sectors, including railways and defence, which should provide a boost to these sectors and free up government capital spending. Banking sector reforms which outline measures for adequate capitalisation of banks and restructure the public sector banks for easy allocation of capital should be among the other key highlights of the budget speech.

The market is perceiving the budget as another important event risk after the elections in May. It will be interesting to see whether India will continue to attract lion’s share of fund flows coming to Asian emerging markets after what has been a terrific last two months in terms of flows.

By Francisco Quintana,
Senior Economist at KCIC, an investment firm investing in Emerging Asia

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